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									 Asia Special Report
                                                                                    NOMURA INTERNATIONAL (HK) LIMITED

 2013 outlook: Asia’s overheating risks                                              November 28, 2012
                                                                                     Principal authors
     Buoyed initially by China, plus very loose policies and robust
                                                                                     Economics, Asia ex-Japan
      capital inflows, we expect Asia’s economies to remain resilient
      to a continued weak outlook in the advanced economies.                         Rob Subbaraman
                                                                                     Chief Economist, AEJ
     The biggest risk is that Asia overheats and central banks find                 +852 2252 1370
      themselves behind the curve in tackling credit booms, asset
      price bubbles and inflation. Watch for policy rate hikes in H2 in
      China, Taiwan, Malaysia, Indonesia and the Philippines.                        FX strategy, Asia ex-Japan
                                                                                     Craig Chan
     In China we highlight three out-of-consensus calls for next year:              Head of FX strategy, AEJ
      CPI inflation rising to over 5% by Q4, interest rates being hiked              +65 6433 6106
      twice, and GDP growth slowing from over 8% in H2 to 7% by Q4.        

     In Asia FX, we are long but expect more differentiation in H2.
      The outperformers are likely to be PHP and MYR; the mid-                       Credit desk analyst
      performers KRW, CNY, SGD and THB; and the underperformers                      Pradeep Mohinani, CFA
      INR, IDR and TWD. We offer seven trade recommendations.                        Head of EM credit desk analysts
                                                                                     +852 2536 7030
     In Asia rates, we are bullish on India bonds and positioned for      

      further bear steepening in China. We remain received in
      Singapore and will position for paying Korea and Taiwan 5yr.
     In Asia credit, we expect a bumpy road to tighter spreads, with
      high yield outperforming. Of Asian sovereigns, the Philippines
      is most likely to see a rating upgrade, whereas India, Sri Lanka
      and Vietnam are potential downgrade candidates.
Any portion of this report that has been prepared by a trading desk analyst is NOT a product of the Fixed Income
Research Department and is NOT covered by the Research Analyst certification provided in Appendix A-1. For additional
information concerning the role of Trading Desk Analysts, please see the important conflicts disclosures beginning at
page 59 of this report. See Appendix A-1 for analyst certification, important disclosures and the status of non-US

Nomura | Asia Special Report                                                                                                          28 November 2012

Table of contents

Overview ....................................................................................................................... 3
   Three growth engines ................................................................................................ 4
   Four risks.................................................................................................................... 5
Zooming in on the key themes and risks .................................................................. 8
   China: Expect surprises on inflation, interest rates and growth ................................. 8
   South Korea: Rates on hold through 2013............................................................... 10
   Hong Kong and Taiwan: property markets pose two-way risk................................. 10
   India: No more short-cuts ......................................................................................... 12
   ASEAN: Spot the difference ..................................................................................... 15
Forecast summary ..................................................................................................... 18
Economic outlook ...................................................................................................... 19
   China: Up in H1, down in H2 .................................................................................... 19
   Hong Kong: Looming fiscal stimulus ........................................................................ 20
   India: A year of consolidation ................................................................................... 21
   Indonesia: Watch policies and politics ..................................................................... 22
   Malaysia: Time for fiscal tightening .......................................................................... 23
   Philippines: Still likely to shine ................................................................................. 24
   Singapore: The (long) road to restructuring ............................................................. 25
   South Korea: Growth to rebound from a very low base ........................................... 26
   Taiwan: External demand holds the key .................................................................. 27
   Thailand: New growth engines ................................................................................. 28
FX outlook: a story of two halves ............................................................................ 29
   First half – appreciation ............................................................................................ 29
   Second half – differentiation..................................................................................... 30
   Seven trade recommendations ................................................................................ 30
   Six themes driving Asia FX in 2013 ......................................................................... 37
Rates outlook: Global factors to dominate early, local drivers emerge in H2 .... 41
   Key recommendations for 2013: SGD, INR and CNY rates .................................... 42
   Rates views across the region ................................................................................. 46
Credit outlook in the EM context.............................................................................. 53
   Key macro drivers for EM credit in 2013 .................................................................. 53
   Asia themes.............................................................................................................. 55
   Asia trade ideas ....................................................................................................... 56
Recent Asia Special Reports .................................................................................... 58

This study was a collaborative effort by Nomura‟s Asia economists and fixed income strategists. Individual
author‟s names and contact details are shown at the top of the sections to which they contributed. The
authors would like to thank David Vincent and Kenneth Persing for editorial and Candy Cheung for research

Nomura | Asia Special Report                                                                                            28 November 2012


Since the global financial crisis, Asia ex-Japan has been instrumental in helping to rebalance              Rob Subbaraman
the global economy. The region‟s total current account surplus has shrunk to 2% of GDP, a                   +852 2536 7435
level not seen since the Asian financial crisis 15 years ago (Figure 1). The shrinkage is not just
due to weak exports but also resilient Asian domestic demand (Figure 2). Unlike in 2008-09,
Asian exports have cooled but not collapsed, so the multiplier effects on domestic demand, via
job losses, have not been as significant, while Asia‟s already-lax policies have become looser.

Fig. 1: Asia ex-Japan’s total current account surplus                    Fig. 2: Contribution to GDP growth (y-o-y), Q1-Q3 2012

 % of GDP                                                                 p.p.
  8                                                                        12                                             Net exports
  7                                                                        10                                             Investment
                                                                             8                                            Consumption
  5                                                                          4
  4                                                                          2
  3                                                                          0
  2                                                                         -2
  1                                                                         -4
  Jun-96         Jun-00        Jun-04      Jun-08           Jun-12

Source: CEIC and Nomura Global Economics.                                Note: All data are Q1-Q3 2012 average except India (H1). Source:
                                                                         CEIC and Nomura Global Economics.
To be sure, the ongoing healing process from balance-sheet recessions will keep the big,
advanced economies fragile in 2013, especially the euro area where we expect more bouts of
financial market turmoil and a slight GDP contraction in every quarter next year. In 2013, we
expect GDP to grow by 1.5% in the US, 0.5% in Japan, and to fall by 0.8% in the euro area
(Figure 3; see Global Annual Economic Outlook for more details of our global forecasts). While
cognizant of the downside risks to global growth, our base case is for the global economy to not
suffer another major heart attack, as it did in late 2008. This distinction is important, for without a
collapse in Asian exports or a mass exodus of foreign capital, non-linear multiplier effects on
domestic demand are unlikely to kick in.

Fig. 3: Nomura’s GDP growth forecasts
                     3Q12      4Q12     1Q13        2Q13        3Q13      4Q13      2012     2013
US                     2.0       1.4      0.7         1.2         2.3       2.7      2.1      1.5
Euro area             -0.6      -1.6     -0.8        -0.6        -0.2      -0.1     -0.5     -0.8
Japan                 -3.5      -1.5      2.0         1.9         1.8       2.0      1.6      0.5
Asia ex Japan          5.9       6.9      6.7         6.6         6.3       6.1      6.3      6.4
  China                7.4       8.4      8.4         8.0         7.4       7.0      7.9      7.7
  Hong Kong            1.3       1.7      2.0         2.5         2.8       2.5      1.2      2.5
  India                5.4       5.3      5.9         6.0         6.1       6.4      5.3      6.1
  Indonesia            6.2       5.7      6.1         6.2         6.0       6.0      6.1      6.1
  Malaysia             5.2       5.1      4.9         4.6         4.0       3.9      5.3      4.3
  Philippines          7.1       6.9      6.7         6.4         6.2       6.2      6.6      6.4
  Singapore            0.3       2.7      2.5         2.2         2.3       2.7      1.8      2.4
  South Korea          1.6       1.8      1.6         2.3         2.9       3.3      2.3      2.5
  Taiwan               1.0       2.7      3.1         3.2         3.6       2.2      1.0      3.0
  Thailand             3.0      15.2      4.0         4.1         4.8       4.9      5.5      4.5
Note: numbers in bold are actual data. For the US, euro area and Japan the growth rates are
seasonally adjusted quarter-on-quarter annualised rates; For Asia ex-Japan the growth rates are
year-on-year. Source: CEIC and Nomura Global Economics.

Hence, our core view is for emerging Asia to display resilience and for the rebalancing to
continue, with Asian domestic demand further increasing its contribution to GDP growth.
Despite slowing growth in the big advanced economies, we expect aggregate GDP growth in
Asia ex-Japan to rise from 6.3% in 2012 to 6.4% in 2013 (see the country outlook chapter for
details). Our over-arching theme for Asia next year is increasing symptoms of overheating, like

Nomura | Asia Special Report                                                                                         28 November 2012

debt build-up, frothy property markets and rising CPI inflation. The biggest risk, in our view, is
that Asian policymakers fall behind the curve in normalising very accommodative macro
policies. This is the crux of our China story of two halves: 8.2% y-o-y GDP growth in H1 2013,
followed by 7.2% in H2.

Three growth engines
We see three main factors supporting Asia‟s rapid economic rebalancing:

China. Contrary to consensus, we have long held the view that China can experience a
policy-led cyclical economic recovery despite its deep structural problems. Fiscal policy
easing really only started in earnest in July after the announcement that Q2 GDP growth had
fallen below 8%; there was no single large-scale stimulus announcement as in late 2008, but
add up all the measures and it is significant. We expect GDP growth to rebound from 7.4%
y-o-y in Q3 to 8.4% in Q4, and to stay above 8% in H1 2013. However, we expect a positive
output gap and accelerating food prices to stoke inflation. We forecast CPI inflation to rise
sharply, to average 5.1% y-o-y in H2 2013, triggering policy tightening. A renewed debt
buildup outside the regulated banking sector – the sum of new trust loans, entrusted loans
and net issuance of bills and bonds has surged in recent months, eclipsing new bank RMB
loans – and slow progress in rebalancing from investment- to consumption-led growth,
urgently require accelerated structural reforms (that can be painful in the short run), or
investor concerns over China‟s sustainable growth are likely to intensify. Either way, we
expect GDP growth to slow to 7% y-o-y by Q4 2013.

GDP growth of 7% may seem weak by China‟s standards, but it is worth remembering that
the size of China‟s economy (at market exchange rates) has almost doubled from USD4.5trn
in 2008 to an estimated USD8.2trn in 2012. The growth of China‟s consumption has not been
weak; in fact, it has been very strong by global standards, it is just that investment growth has
been even stronger. On our estimates, 2012 is set to be the crossover year when the annual
increase in nominal personal consumption in China (USD478bn) permanently surpasses the
US (USD403bn). What is more, two-thirds of US consumption is on services, which are less
internationally tradable than goods. Narrowing the consumption comparison to nominal retail
sales shows that it will not be long before China is the world‟s biggest consumer of goods
(Figure 4). China‟s much larger economy growing at a moderately slower pace is still a very
powerful growth pole for the rest of Asia, so much so that the rest of Asia‟s aggregate exports
to China (and its entrepôt, Hong Kong) are now bigger than to the US and EU combined
(Figure 5).

Fig. 4: Nominal retail sales in China and the US                      Fig. 5: Asia ex-China’s exports to China+HK, US and EU

 USD bn                                                                USDbn
 400                                                                    70
 350               US                                                                   China+HK
 300               China                                                                EU
                                                                        50              US
 200                                                                    40
  50                                                                    20

   0                                                                    10
   Oct-92      Oct-96      Oct-00   Oct-04   Oct-08   Oct-12             Aug-03     Aug-05      Aug-07    Aug-09      Aug-11
Source: CEIC and Nomura Global Economics.                             Note: Asia ex-China includes India, Indonesia, Japan, Korea,
                                                                      Malaysia, Philippines, Singapore, Taiwan and Thailand.
                                                                      Source: CEIC and Nomura Global Economics.
Loose policies. The central banks in China, India, Indonesia, Korea, Thailand and the
Philippines have all cut policy rates this year and, adjusted for inflation, real policy rates are
historically low across Asia. But what is less appreciated is the extent of easing on the fiscal
side: many other Asian governments are mimicking China, taking advantage of their low debt –
this year public debt is below 50% of GDP in all emerging Asian countries except Malaysia
(53%) and India (68%), compared to an average of 118% of GDP for the G20 advanced
economies – and shifting to more expansionary fiscal policies. Hong Kong, Malaysia, Thailand
and the Philippines release timely monthly fiscal data, which show that their combined budget

Nomura | Asia Special Report                                                                                              28 November 2012

deficit in the 12 months to September is almost as large as it was after the global financial crisis
(Figure 6). In the advanced world, loose monetary policies are being offset by fiscal austerity; in
emerging Asia, both policies work together and are more effective. Low unemployment, solid
credit growth and positive wealth effects from buoyant property markets are conspiring with
these loose macro policies to bolster domestic demand. There are, however, some exceptions:
India has limited room to use countercyclical policies due to high inflation and poor fiscal
finances; Korea‟s loose policies are being dampened by a household sector overburdened with
debt; and Singapore has refrained from fiscal easing as it focuses on raising productivity.

Capital inflows. Net foreign capital inflows to Asia have significant scope to intensify in 2013.
The most comprehensive gauge, which captures FDI, portfolio debt and equity flows, as well as
cross-border foreign bank claims, is the financial account of the balance of payments. Using this
measure (Figure 7), we see that, in the space of just two and a half years since the crisis (Q1
2009 to Q2 2011), net capital inflows to Asia ex-Japan totalled a massive USD783bn, more than
the USD573bn in the five years prior, “pulled” by Asia‟s relatively higher growth prospects and
“pushed” by central bank quantitative easing in advanced economies (which, through portfolio
rebalancing, has spill-over effects on emerging markets by pushing investors into riskier assets).
While volatile in recent quarters, we expect another large bout of net inflows, buoyed by China‟s
economic recovery, the fading of US fiscal cliff fears, QE3 and the increasing search for yield.
There certainly seems to be room for more inflows. A glaring example is the widening gap
between the shares of emerging Asia in world GDP and in the MSCI world equity index, despite
Asia‟s superior economic fundamentals relative to the advanced world (Figure 8). Another large
bout of net capital inflows would accelerate Asia‟s rebalancing via: 1) currency appreciation,
which crimps exports; or 2) likely FX intervention and central banks keeping interest rates lower
than they would otherwise, thereby easing liquidity conditions and buoying asset markets.

Fig. 6: Government budget positions                                        Fig. 7: Asia ex-Japan’s net capital inflows

 USD bn, 12-month rolling sum           USD bn, 12-month rolling sum       US$bn           USD            QE1     USD
 100                                                              20       120             573bn       announced 783bn
   50                                                            10         90
    0                                                                       60
  -50                                                                       30
 -100                                                                        0
 -150               China, LHS                                             -30
 -200                                                           -30
                    Rest of Asia, RHS                                      -60                                   QE2
 -250                                             -40                                                         announced
    Sep-03 Mar-05 Sep-06 Mar-08 Sep-09 Mar-11 Sep-12                         Jun-03 Dec-04 Jun-06 Dec-07 Jun-09 Dec-10 Jun-12

Note: Rest of Asia is the aggregate fiscal balances of Hong                Note: Countries are China, HK, India, Indonesia, Korea, Taiwan,
Kong, Malaysia, Thailand and the Philippines. Source: CEIC.                Malaysia, Philippines, Singapore and Thailand. Source: CEIC.

Four risks
The risk we are most concerned with is that some Asian economies may overheat.

Overheating. In our view, there is too much reliance on countercyclical policies to counter weak
exports and not enough focus on structural reforms to boost the supply-side of economies. In
October, the real interest rate on 1yr bank deposits in China was 1.3%, while in the rest of Asia
the average real policy rate, weighted by GDP, was just 0.3% – and this is during a period of
low inflation in the region (Figure 9). Central banks justify erring on the side of laxity as
insurance against the downside risks to global growth, to promote domestic demand given the
weakness of exports and to avoid provoking too-strong capital inflows. From 1999 to 2005, we
estimate that the real interest rate was negative 19% of the time in China and 10% of the time
elsewhere in Asia, while from 2006 to 2012, this grew to 57% and 43%, respectively. But
persistently negative real rates sow the seeds of overheating, and Asia‟s real policy rate is likely
to turn negative again as inflation rises.

Nomura | Asia Special Report                                                                                                      28 November 2012

Fig. 8: Asia emerging market share in world GDP and MSCI                   Fig. 9: Real policy interest rates (deflated by headline CPI)

  % share                                                                    % p.a.                     China's real bank deposit rate
                                                       IMF forecasts         7
 25               Asia EM share in world MSCI                                                           Rest of Asia's real policy rate
                  equity index                                               5
                  Asia EM share in world GDP                                 4
 17               (at market exchange rates)                                 3
 13                                                                          1
   9                                                                        -1
   5                                                                        -3
   1                                                                        -5
    1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016                   Oct-00   Oct-02   Oct-04    Oct-06     Oct-08    Oct-10      Oct-12
Note: Asia EM is China, India, Indonesia, Malaysia, Korea,                 Note: For the rest of Asia, the real policy rate is GDP weighted of
Philippines, Taiwan and Thailand. Source: MSCI and IMF.                    Hong Kong, India, Indonesia, Korea, Malaysia, Philippines,
                                                                           Singapore, Taiwan and Thailand. Source: Bloomberg and CEIC.

Negative side effects are already emerging: credit has been growing faster than nominal GDP
across the region, and property markets are frothy in many capital cities. If we overlay
residential property prices in the US (indexed to 100 in January 2000) on residential property
prices in several Asian countries or major cities (indexed to 100 in December 2008), it is striking
that prices in Hong Kong, India, China and Taipei are tracking above the US price bubble
(Figure 10). We see a danger in the likely increased use of macroprudential measures in an
attempt to cool property markets and credit growth; these measures may work for a while but
over time, as loopholes are found, they turn out to be a poor substitute for higher interest rates.
Hong Kong is a case in point. The Hong Kong Monetary Authority has progressively imposed
higher stamp duties on property transactions and tighter restrictions on mortgage lending on six
occasions since late 2009, but the property market has yet to cool (Figure 11). Central banks
ultimately find themselves behind the curve in tackling credit booms, asset price bubbles and
inflation. Hong Kong seems most at risk, but we cannot rule out overheating in other countries,
including China, India, Indonesia, Singapore and Taiwan.

Fig. 10: Residential property prices in Asia and the US                    Fig. 11: Hong Kong polices to cool residential property price

Index                                                                       Index, 1999=100
210                                                                          250

170                                                                                                                                                     6
150                                           China, Dec-08                 150
130                                           HK, Dec-08                                                                                       34
                                              India, Dec-08                                                                                   2
110                                           Kuala Lumpur, Dec-08                                                                        1
                                              Singapore, Dec-08
 90                                           US, Jan-00
                                              Taipei, Dec-08
 70                                                                           50
       t    t+1     t+2    t+3   t+4    t+5      t+6       t+7                 Jan-93 Jan-96 Jan-99 Jan-02 Jan-05 Jan-08 Jan-11

Note: Wherever possible official property price measures have              Note: 1) Oct 09, cut loan-to-value (LTV) ratio; 2) Feb 10, stamp
been used. Data are either monthly or quarterly, while t=number            duty hike; 3) Aug 10, cut LTV ratio; 4) Nov 10, seller stamp duty
of years from the starting date (Jan 2000 for the US and Dec               hike to as high as 15% and cut LTV ratio; 5) Jun 11, cut LTV ratio;
2008 for Asia). China‟s index is the average of Shanghai,                  6) Oct 12, stamp duty hike to as high as 20% plus new buyer stamp
Beijing, Shenzhen, Guangzhou and Tianjin; India‟s is the                   duty of 15% for non-permanent residents.
average of all major cities; the US index covers 898 counties.             Source: CEIC, HKMA and Nomura Global Economics.
Source: CEIC, Centa Property; US CoreLogic and Nomura
Global Economics.

Commodity price surge. Despite lacklustre growth in the advanced economies, the global
search for yield and strengthening demand in emerging economies (especially Asia), could fuel
another surge in global commodity prices, particularly food prices. The global supply-demand
equation for food remains tight. The supply side of the food equation is being constrained by: 1)
insufficient new investments for large agricultural productivity gains; 2) competing use of
available land due to biofuels, urbanisation and industrialisation; and 3) increasing uncertainty

Nomura | Asia Special Report                                                                          28 November 2012

due potential for QE-driven commodity price speculation and more volatile weather due to
global warming. On the demand side, the relevance of the world‟s most populous countries
being in the sweet spot of rapid economic development should not be underestimated. The size
of the annual increase in China‟s personal consumption is about to overtake that of the US, to
become the world‟s largest. This is important. For unlike other commodities, the sensitivity of the
demand for food to an increase in personal income is much greater for lower-income countries,
as is the changing of diets toward a higher calorie intake. A surge in the global price of food
items, which on average accounts for 31% of Asia‟s CPI basket versus 14% in the US, could lift
Asia‟s CPI inflation sharply and hurt growth, notably in India, Indonesia, and the Philippines.

Recoupling. Trend GDP growth in Asia ex-Japan is around 7%, a full 5 percentage points (pp)
higher than in advanced economies. Or put more starkly, real GDP is above its pre-global
financial crisis peak by 41% in China, 31% in India, 25% in Indonesia and 11% in Korea
compared with 2.3% in the US and still 2.4% below in the euro area. From this vantage point, in
long-run trend terms there is a widening divergence between emerging Asia and the advanced
world (Figure 12). However, in terms of short-run dynamics, the global financial crisis has
debunked any notion that Asia can decouple from advanced economies at times of extreme
dislocation. During 2008-09, the peak-to-trough decline in year-on-year real GDP growth was
between 10pp and 17pp in Hong Kong, Korea, Malaysia, Singapore, Taiwan and Thailand – all
larger than the declines in the US (-6.2pp) or euro area (-7.3pp). While relatively strong
economic and policy fundamentals have helped buffer Asian economies against sub-par growth
in the US and euro area, another deep recession in the advanced world would be a completely
different story; one in which Asia hits a tipping point where non-linear effects kick in from a
collapse in exports and foreign capital flight. Those economies that are very open to trade
(Hong Kong, Singapore, Malaysia), have sizable current account deficits (India and Indonesia)
or are structurally weak domestic economies (Korea) are most vulnerable.

Fig. 12: Long-run trends in real GDP growth of Asia ex-Japan vs advanced economies

 %                                    Long-run trends
  8                                                                                forecasts


 -2           Major advanced economies (G7)             Asia ex-Japan
      1980       1985          1990     1995       2000        2005         2010   2015

Source: IMF, CEIC and Nomura Global Economics.

China hard landing. In November 2011, we published an Anchor Report, China risks, in which
we analyzed China‟s structural challenges – ranging from overinvestment and increasing
shadow banking activities to over-privileged state-owned enterprises – and concluded that they
had become too big to ignore. While our base case is for China‟s GDP growth to average 7.7%
in 2012-14, we concluded that the macro risks were sufficiently large to assign a one-in-three
likelihood of China experiencing a hard economic landing before the end of 2014, which we
defined as real GDP growth averaging 5% y-o-y or less over four consecutive quarters. To help
quantify the macro risks on an ongoing basis we developed the Nomura China Stress Index
(CSI), which is a composite of 18 vulnerability indicators. The CSI indicates that hard-landing
risks have been on the rise since 2003, a trend that steepened after the global financial crisis.
The CSI remains near an all-time high and we therefore maintain our view of a one-in-three
likelihood of a hard landing. A China hard landing would have a significant impact on the global
economy, but especially Asia. A recent IMF study estimated that each percentage point decline
of investment growth in China would lower GDP growth by more than 0.5pp in Korea, Taiwan
and Malaysia.

Nomura | Asia Special Report                                                                                         28 November 2012

Zooming in on the key themes and risks
When one looks more specifically at the individual economies in the region, it quickly becomes
apparent that Asia should not be treated as one homogeneous region. Several countries are
likely to raise interest rates next year (China, Malaysia, Indonesia, the Philippines and Taiwan)
but not all face overheating risks (Korea). Some are more vulnerable to a sudden stop in capital
inflows (India and Indonesia), while China looks set to experience the sharpest slowdown in
GDP growth in H2 2013.

China: Expect surprises on inflation, interest rates and growth
We highlight three out-of-consensus calls: inflation rises to higher than consensus, two                    Zhiwei Zhang
rate hikes in 2013 and a growth slowdown in H2 2013.                                                        +852 2536 7433

Inflation will rise to higher than the consensus forecast                                                   Wendy Chen
                                                                                                            +86 21 6193 7237
We believe inflation will rise to 4.2% in 2013, higher than the consensus forecast of 3.2%. There 

are both structural and cyclical reasons behind higher inflation. We presented seven structural
reasons in our thematic report, The case for structurally higher inflation in China, 21 September
2011. These structural reasons remain valid for China‟s inflation outlook in 2013.

We are also concerned about inflation from a cyclical perspective. While GDP growth has
slowed to 7.4% in Q3, we believe the economy is running close to its (slowing) potential growth
rate for two reasons. First, the labour market remains tight as the ratio of job openings to job
seekers has stayed above 1 (Figure 13). With low quality unemployment data, this ratio has
been useful in gauging labour market tightness – it dropped sharply in Q4 2008 after the global
financial crisis affected China‟s exporters, and recovered quickly after the government released
its 2009 stimulus package. Despite GDP growth decelerating from 12.1% in Q1 2010 to 7.4% in
Q3, this ratio has consistently remained above 1, which suggests that the excess labour supply
in China has been depleted and potential growth may have slowed to around 7.0-7.5%.

Second, non-food inflation month-on-month has, in recent months, been running higher than its
historical average (Figure 14). While there is more focus on headline year-on-year CPI inflation,
we do not believe it fully reflects the underlying inflationary pressures as it is dominated by
volatile food prices and base effects. We think month-on-month non-food inflation is a better
indicator for determining the cyclical position of the economy. The fact that it is still running at a
3.6% annualised rate in October suggests that the economy is running close to its potential.

Fig. 13: Labour demand/supply ratio and real GDP growth                 Fig. 14: Non-food CPI inflation

Ratio                 Labour demand/supply ratio   % y-o-y              % m-o-m
1.1                   Real GDP growth, rhs              16              0.4
1.0                                                     14                         Historical average

0.9                                                     12
0.8                                                     10

0.7                                                     8

0.6                                                     6               0.0
  Sep-03             Sep-06         Sep-09         Sep-12                         July         Aug        Sept         Oct
Source: CEIC and Nomura Global Economics.                               Source: CEIC and Nomura Global Economics.

If growth is currently running near its potential, policy easing will likely push growth to above its
potential in Q4 and H1 2013, which would drive up inflation. The central government approved
an estimated RMB1trn with of infrastructure projects last summer, with implementation
beginning in Q4. Total social financing rose to RMB 1.6trn in September and RMB 1.3trn in

Nomura | Asia Special Report                                                                                       28 November 2012

October. The planned railway infrastructure investments will also likely pick up to RMB530bn in
2013 from RMB516 in 2012, according to the 21st Century Business Herald. There have been
positive leading indicators in the housing sector as well. We expect overall investment growth in
China to accelerate, at least in H1 2013, which should drive GDP growth above 8%.

Two interest rate hikes in H2 2013
Unlike consensus, which expects inflation to be mild and interest rates to remain unchanged
throughout 2013, we believe there will be two rate hikes in H2 2013, as inflation should rise to
above 4% by mid-year. The inflation target for 2013 has not yet been set, but we believe it will
remain unchanged at 4% at the Central Economic Working Conference in December. The most
recent rate hike cycle began in October 2010 when CPI inflation rose above 4%. Moreover we
believe the government has recently become more tolerant of slower growth and less tolerant of
inflation. This was reflected in the Q3 monetary policy report, which added this new statement:
“The economy has become less sensitive to the constraint imposed by employment, and more
sensitive to constraint imposed by inflation”.

Moreover the government may tighten policy if there are other signs of risk in the economy,
such as sharp rebound of housing prices and over-leverage in the financial system. Housing
prices in October already rose month-on-month in 35 out of the 70 major cities surveyed by the
government, up from 31 in September. The sharp rise in total social financing suggests that
leverage is building in the corporate sector which will likely be a concern of regulators in 2013.

GDP growth slows down in H2 2013
We believe GDP growth in 2013 will be a story of two halves: averaging 8.2% in H1 2013, but
then slowing noticeably to 7.2% in H2 2013. This differs from the consensus which expects
growth to rise through most of 2013 (Figure 15). Our cautious view is premised upon our above-
consensus inflation forecast and consequent policy tightening. We also believe that the current
round of policy easing will lead to rising risks in the financial system, and the government will
probably have to rein in the rapid credit increases from trust loans at some point in H1 2013.

New trust loans rose to RMB202.4bn in September and RMB144.5bn in October (Figure 16).
According to China Real Estate Journal, about 40% of these loans went to infrastructural
projects with an average guaranteed interest rate of 7-8%. We believe such a rapid expansion
of credit to the infrastructure sector at such a high average interest rate is indicative of a
potential bubble and increased default risks. The government is well aware of these risks, as it
tightened regulations on trust loans in the summer of 2011 to control the financial risks, but then
had to loosen regulations in 2012 to prevent the economy from slowing further. We believe the
current boom in trust loans is not sustainable, and expect the government to tighten regulations
on trust loans again in H1 after the leadership transition is completed and growth recovers.
Once the pace of credit supply growth normalises, GDP growth will likely slow toward its
potential of about 7.0-7.5%.

Fig. 15: Consensus versus Nomura forecasts for 2013 real             Fig. 16: New trust loans since January 2011
GDP growth in China
                                                                      RMB bn
% y-o-y
                               Consensus forecast                     240
                               Nomura                                 210

8.5                                                                   180
8.0                                                                   120

7.0                                                                    30
6.5                                                                   -30
   1Q12 2Q12 3Q12 4Q12 1Q13 2Q13 3Q13 4Q13                                  Jan-11    Jun-11      Nov-11   Apr-12       Sep-12
Source: CEIC and Nomura Global Economics.                            Source: CEIC and Nomura Global Economics.

Nomura | Asia Special Report                                                                                               28 November 2012

South Korea: Rates on hold through 2013
We expect the Bank of Korea to keep rates unchanged at 2.75% through 2013 as                                   Young Sun Kwon
                                                                                                               +852 2536 7430
GDP growth and CPI inflation should rise modestly from a very low base.                              

The KRW swap curve is pricing in -15bp of cuts in 12 months as of 27 November (see Asia
Local Market Rate Expectations, 28 November 2012). Based on a Taylor Rule-type monetary
policy reaction function – which we estimate from the policy responses to the output gap and
inflation gap since 2000 – our 2013 GDP growth (2.5%) and CPI inflation (2.7%) forecasts
suggest a 25bp cut in 2013, yet the Bank of Korea‟s (BOK) official GDP growth (3.2%) and CPI
inflation (2.7%) forecasts suggest no cut in 2013 (Figure 17).

Despite the Taylor Rule indicating a 25bp cut based on our GDP and CPI forecasts, we firmly
believe that the BOK will keep rates on hold at 2.75% through 2013. GDP growth and CPI
inflation should rise modestly, but only from a very low base, supported by inventory restocking
in Q4 and a modest recovery of foreign demand in 2013. Although our 2013 GDP growth
forecast is a below-consensus 2.5%, it is not as weak as it may first appear once allowance is
made for a very powerful base effect. Our quarter-on-quarter GDP growth forecast on a
seasonally adjusted annualised rate (saar) averages 3.3% in 2013. The discrepancy between
having an annual GDP growth forecast that is lower than average quarterly growth (saar)
forecast is explained by 2013 GDP starting from a very low base in H2 2012 (Figure 18).

We expect the BOK to focus on quarter-on-quarter growth and therefore to see little need to cut
rates further. We would only expect the BOK to cut rates should quarterly GDP growth fall far
below Q3 2012‟s 0.156% (sa, q-o-q), but this is not our base case. Between Q1 2000 and Q3
2012 (47 quarters) the historical probability of quarterly growth coming in below 0.156% is 11%.
In other words, over that period only five quarters have seen growth that low – and these were
associated with the dotcom bubble bursting in 2001, the credit card crisis in 2003 and the global
financial crisis in 2008. We do not expect growth to slump that badly, unless one of the major
downside risks to global growth (the US fiscal cliff; a renewed eurozone sovereign crisis; a
China hard landing) actually materialises, but none of these are held in Nomura Global
Economics‟ base case.

Fig. 17: Nomura’s Taylor Rule-type estimates for policy rate              Fig. 18: Nomura’s Korea GDP, CPI and BOK policy forecast

     %               Actual BOK policy rates                                           GDP growth (seasonally adjusted annualized rate)
 6                   Fitted based on BOK forecasts                                     CPI inflation (y-o-y)
                     Fitted based on Nomura forecasts
                                                                 F                     BOK policy rates

 5                                                                        5                                         Forecast




 1                                                                        0
 Mar-00             Mar-04           Mar-08             Mar-12            Mar-11               Mar-12               Mar-13

Note: Policy rate = neutral rate + a [output gap] + b [inflation gap]     Source: CEIC and Nomura Global Economics estimates.
+ policy rate (-1). Source: Nomura Global Economics estimates.

Hong Kong and Taiwan: property markets pose two-way risk                                                          Young Sun Kwon
                                                                                                                  +852 2536 7430
We see the risk that property prices rise further due to very low interest rates and                    
ample liquidity.
                                                                                                                  Aman Mohunta
Aside from the main external risks (the US fiscal cliff; a renewed eurozone sovereign crisis; a                   +91 22 6617 5595
China hard landing), property markets in Korea, Taiwan and Hong Kong may all turn out to be
sources of up- or downside risks to our growth outlook. Since 2009, house prices have surged

Nomura | Asia Special Report                                                                                           28 November 2012

in Hong Kong and Taipei, while Seoul has seen house prices fall (Figure 19). As a result, Hong
Kong and Taiwan have tightened while Korea has eased property market regulations:

          Hong Kong: The Hong Kong Monetary Authority (HKMA) introduced in September
           2012 a new round of measures to strengthen risk-management in mortgage-lending.
           For borrowers with multiple properties under mortgage, the debt servicing ratio (DSR)
           limit was lowered from 50% to 40% and the maximum loan-to-value (LTV) ratio was
           reduced from 40% to 30%. The financial secretary also announced a 15% buyer stamp
           duty charged on all residential properties acquired by non-permanent residents,
           including corporate owners.
          Taiwan: In 2011, the Central Bank of China (CBC) tightened prudential measures to
           stabilise the property market, including the introduction of a 60% LTV cap on second or
           more housing loans for home purchases in specific areas (Taipei and some districts in
           New Taipei City). Also, the ministry of finance imposed a Specifically Selected Goods
           and Services Tax: a 10-15% levy on the sale price of non-self-use residences and city
           land with building permits that were bought less than two years ago.
          South Korea: In September 2012 the Financial Services Commission raised the debt-
           to-income (DTI) ratio from 40% to 50% in the three Gangnam districts (known as
           „speculative‟ zones). The government also cut the acquisition tax by 50% on all home
           purchases and the transfer tax on unsold apartments purchased before end-2012.

Between June 2010 and July 2011, the BOK and the CBC hiked policy rates by 125bp and
62.5bp, respectively. Although Taiwan‟s GDP growth should slow from 4.0% in 2011 to 1.0% in
2012 – much sharper than that of Korea, from 3.6% to 2.3% – the CBC has kept rates
unchanged while the BOK has cut rates by 50bp. We believe that this is partly due to different
housing market conditions. Due to the USD/HKD peg, Hong Kong has had to keep short-term
rates extremely low, in line with the US Fed, despite surging property prices (Figure 20).

In 2013, our property analyst expects Hong Kong property prices to stall as home prices
become less affordable as household income growth slows (see Hong Kong property outlook
2013: Walking a tightrope, 21 November 2012). Taipei property prices should be stable too, but
Seoul house prices should continue to fall modestly.

However, the risk we see is that property prices rise further in Hong Kong and Taiwan due to
very low interest rates and ample liquidity. If this happens, both governments would likely
impose more administrative tightening measures and curb credit growth, as the ratio of
mortgage loans-to-GDP is high in Hong Kong (41% in 2011) and Taiwan (40%), compared with
Korea‟s 25%. An eventual policy-induced property market correction would have a large
negative impact on Hong Kong and Taiwan. Meanwhile, Korea‟s property market points to
potential upside risks to our growth outlook if the new government eases mortgage financing
regulations aggressively (but this is not our base case).

Fig. 19: House price index in Seoul, Taipei and Hong Kong            Fig. 20: Policy rates in Korea, Taiwan and Hong Kong

  2008=100                              Hong Kong                         %                                            Hong Kong
180                                                                                                                    South Korea
                                        Seoul                         9
                                        Taipei                        8

100                                                                   4
 40                                                                   0
  Sep-94              Sep-00        Sep-06          Sep-12            Oct-00       Oct-03        Oct-06       Oct-09         Oct-12

Source: CEIC and Nomura Global Economics.                            Note: Discount rate is for HK and Taiwan. 7day repo rate is for
                                                                     South Korea. Source: CEIC and Nomura Global Economics.

Nomura | Asia Special Report                                                                                        28 November 2012

India: No more short-cuts

Correcting fiscal finances will lead to medium-term gains; not doing so, will lead to                   Sonal Varma
                                                                                                        +91 22 403 74087
more pain. Either way, the economy will experience high inflation and slow growth.            

                                                                                                        Aman Mohunta
India‟s GDP growth plummeted to a 10-year low of 5.3% y-o-y in 2012, due to weak global                 +91 22 6617 5595
demand, domestic policy paralysis and high interest rates. Recent reform announcements are    
positive for market sentiment, but have yet to be implemented (see: India reforms (Part I): A
long way to go, 25 October 2012) and a lot hinges on whether the government corrects its fiscal
finances for real and not just on paper. Due to the close proximity to elections, we fear only the
latter, and so we expect a shallow recovery in 2013 (6.1%), below consensus, as supply-side
constraints, sticky inflation and weak exports combine to depreciate the rupee, which in turn
feeds into inflation and limits the extent of rate cuts. We set out five themes to watch in 2013.

A year of productivity growth
Lack of investment is one of the fundamental reasons behind India‟s slowing potential growth,
but falling productivity is also responsible (see India: Make or break, 2 May 2012). India‟s
incremental capital output ratio (ICOR), a measure of capital productivity, has risen from 3.6 in
2007 to above 5 in 2012, suggesting falling capital productivity (Figure 21). Slow
land/environment clearances are responsible for project delays and rising costs. In 2013, we
expect productivity to improve as the setting up of the National Investment Board and faster
approvals free many existing projects from bottlenecks that have thus far stymied progress.

However, we do not expect fresh investments to revive in 2013 as the conditions for an
investment take-off (as seen in 1994 and 2004) are not yet in place: low and stable inflation, a
sustained rise in profitability, low cost of capital, fiscal consolidation and higher global growth.
We believe that it will take time to raise potential growth again – it took the accumulation of over
a decade of reforms to lift potential growth in the mid-2000s. The government‟s diktat to public
sector undertakings (PSUs) to „use or lose‟ cash may not be able to offset the drag from weak
private investment as the private sector (corporates plus households) account for the bulk (70%)
of total investments and private sector corporate savings far exceed PSU savings (Figure 22).

Fig. 21: Incremental capital output ratio                             Fig. 22: Corporate savings: private versus government

 Unit                                                                   % of GDP
7.5                 Incremental Capital Output Ratio (ICOR)                         Private Corporate (non-financial)
                    ICOR (5-year moving average)                                    Government companies & statutory corporations
6.5                                  Falling capital                     8
4.0                                                                      2
3.0                                                                      0
      1993             1999           2005             2011                  1971 1976 1981 1986 1991 1996 2001 2006 2011

Note: ICOR (t+1) = Investment-to-GDP (t)/Real GDP growth              Source: CEIC and Nomura Global Economics.
(t+1). Source: CEIC and Nomura Global Economics estimates.

The consumption binge is behind us
Despite a sharp investment slump since 2007, real private consumption remained resilient
during 2006-11, growing at an annual average of 8.0-8.5%, aided by expansionary fiscal policy
and rising wages. Some of the drivers are still in place (such as the 15-20% rise in rural wages
this year), but we do not see this consumption binge continuing for long as the government is
running out of fiscal bullets and persistently high inflation is squeezing purchasing power. We
expect consumption demand to remain in low-gear, growing at a more muted 4-5% y-o-y in
2013 (Figure 23).

Nomura | Asia Special Report                                                                                          28 November 2012

The extent of future weakness in consumer demand depends on fiscal policy. If the government
substantially consolidates its fiscal finances through a cut in outlay on inclusive growth schemes
and a steep hike in fuel prices, then we would expect consumption growth to dive sharply.
However, even if it does not – which is our base case – the outlay on flagship programmes
should plateau due to tight fiscal constraints, and government spending would cease to be an
incremental driver of consumer demand. Moreover, the non-farm sector, which now constitutes
close to 70% of rural GDP, slowed sharply in 2011-12 and will have a lagged dampening effect
on rural demand. With urban demand already subdued due to high interest rates, high inflation
and weak job market prospects, we expect overall consumption growth to remain weak.

A year of currency weakness
For a fourth consecutive year, we expect India‟s current account deficit to remain above
sustainable levels at 3.8% of GDP in 2013. High inflation and domestic supply-side bottlenecks
are leading to import substitution in sectors such as rubber products, toys, electronics, electrical
equipment, capital goods, textiles and consumer goods. Energy demand remains largely
inelastic, despite recent fuel price hikes, due to a large arbitrage between petrol and diesel
prices and unavailability of gas. With global demand still weak, we expect India‟s trade deficit to
remain elevated. Moreover, invisibles no longer provide an offset to a worsening trade deficit as
services exports are growing at a slower pace and investment income outflows are on the rise.

India needs consistent capital inflows just to finance the deficit and to avoid digging into its FX
reserves. Already, import cover of foreign currency reserves has fallen below six months for the
first time since 1997, highlighting the growing external vulnerability (Figure 24). Global push
factors can lead to a sudden surge in capital inflows, but with domestic inflation still high, the
resultant real effective exchange rate appreciation will only eat into export competitiveness (see
India's chronic balance of payments, 3 September 2012). India needs aggressive reforms to de-
bottleneck investments plus tighter fiscal policy and/or higher interest rates. In their absence, we
expect the burden of adjustment to fall on the currency, with INR/USD depreciating to 60 in H2
2013, a new record high.

Fig. 23: Real private consumption growth                              Fig. 24: Import cover of FX reserves

  % y-o-y                                                              Months
  10                             Private                               18                   Import cover of FX reserves
    9                                                                   16
    5                                                                   10
    4                                                                    8
    0                                                                    2
        1988     1993          1998    2003   2008     2013              Oct-92    Oct-96     Oct-00    Oct-04     Oct-08    Oct-12

Source: CEIC and Nomura Global Economics estimates.                   Source: CEIC and Nomura Global Economics estimates.

Politics to drive fiscal policy in H2 2013
The threat of a credit rating downgrade suggests that the government will present a balanced
FY14 budget in February 2013. We expect the government to target a fiscal deficit of 4.8% of
GDP in FY14, in line with the Kelkar Committee recommendations (see India: New fiscal
consolidation roadmap lacks details , 29 October 2012). However, we expect this consolidation
to appear only on paper and not in practice – we forecast fiscal deficits of 5.8% and 5.2% of
GDP for FY13 and FY14 – as the political calendar gets busier, raising the risk of politics
dominating economics. After the Gujarat state elections in December, 10 other autonomous
states are due to hold assembly elections in 2013, two more in H1 2014 and then the general
election must be held by May 2014 (Figure 25). In the 2009 election, the government leveraged
the rural employment guarantee (MG-NREGA) and farm-debt waiver schemes to woo voters.
While the fiscal position is worse now, populist acts such as delaying tough decisions (like

Nomura | Asia Special Report                                                                                             28 November 2012

raising fuel and fertilizer prices) or announcing new schemes (the Food Security Act) cannot be
ruled out, especially if state elections show the ruling UPA government losing its grip on power.

India cannot afford populist measures. Fiscal consolidation has historically been achieved via
higher revenues rather than less expenditure. Expenditure compression is difficult since
consumption (wages, salaries, services) and transfer payments (interest payments, grants,
subsidies, pensions) together account for 75% of total expenditure, and tends to rise in line with
inflation. In addition, we expect INR depreciation to raise the cost of imported oil, keeping the
subsidy bill elevated. Revenue gains due to the implementation of the goods & services tax and
cost savings by the direct cash transfer scheme are unlikely in 2013, in our view. With the
economic recovery set to be shallow, we expect only a slight uptick in tax buoyancy. As such,
the structural fiscal deficit will remain large and, more likely, the government will rely on asset
sales (disinvestment, land monetisation, telecom spectrum auctions) to plug the revenue hole.

Window for rate cuts closes in H2 2013
The Reserve Bank of India (RBI) has guided for a rate cut in Q1 2013, saying at its October
policy meeting that “the baseline scenario suggests a reasonable likelihood of further policy
easing in the fourth quarter of this fiscal year [Jan-Mar].” We concur. INR appreciation in
September due to the government‟s reform announcements and global liquidity easing, along
with a slight moderation in commodity prices, led to a surprise moderation in WPI inflation to
under 7.5% y-o-y in October, pushing core WPI inflation to a five-month low of 5.2%. We expect
a favourable mix of supply (lagged effect of INR appreciation, lower commodity prices, good
winter crop prospects), demand (negative output gap) and technical (base effects) factors to
moderate core inflation further in Q1 2013, paving the way for a 50bp repo rate cut in H1 2013.

However, we expect this window of easing to close in H2. By Q3 2013, upside pressures on
inflation are likely to build again. First, India‟s potential growth has fallen to under 7% and so it
does not take much of a GDP recovery for the output gap to quickly close and start exerting
upward pressure on inflation (Figure 26). Second, imported inflation is likely to build due to INR
depreciation in H2 2013, raising input costs and translating into higher output prices due to a
narrower output gap. Third, with an eye on the upcoming elections, we expect the government
to raise minimum support prices for food grains and enact the Food Security Act, adding to food
price inflation pressures. As a result, we expect inflation momentum to start to inch higher, core
inflation to inch back towards 5.5-6.0% by Q4 2013 and the RBI to stay on hold in 2H 2013.

We maintain our view that space for rate cuts remains very limited because of the persistence of
large twin deficits (fiscal and current account) and sticky inflation. Rate cuts in H1 should not be
interpreted as the start of an aggressive rate easing cycle. This time is, indeed, different.

Fig. 25: Election schedule                                             Fig. 26: Output Gap and WPI inflation

                        End of   Rulling    Seats in Lok                    pp      Output Gap, lhs      Core-WPI, rhs    % y-o-y
   State/House                                                          4
                         term     party       Sabha
     Gujarat            Jan-13   NDA/BJP         25                     3                                                 F         8
   Meghalaya            Mar-13   UPA/INC         2                      2
     Tripura            Mar-13    CPI (M)        2                                                                                  6
    Nagaland            Mar-13     NPF           1
   Karnataka            Jun-13   NDA/BJP         28                     0
 Madhya Pradesh         Dec-13   NDA/BJP         29                    -1
    Mizoram             Dec-13   UPA/INC         1
      Delhi             Dec-13   UPA/INC         7                                                                                  2
    Rajasthan           Dec-13   UPA/INC         25                    -3
  Chhatisgarh           Jan-14   NDA/BJP         11                    -4                                                           0
     Sikkim             May-14     SDF           1
   Lok Sabha            May-14   UPA/INC        545
                                                                       -6                                                         -2
                                                                            Q405      Q407        Q409        Q411            Q413

Notes: UPA- United Progressive Alliance; INC- Indian National          Source: CEIC and Nomura Global Economics.
Congress; NDA- National Democratic Alliance; BJP- Bhartiya
Janata Party; CPI (M) – Communist Party of India (Marxist);
SDF- Sikkim Democratic Front. Source: Election Commission
and Nomura Global Economics.

Nomura | Asia Special Report                                                                                                                  28 November 2012

ASEAN: Spot the difference

ASEAN has been resilient, but it is a diverse grouping of Southeast Asian countries,                                              Euben Paracuelles
                                                                                                                                  +65 6433 6956
with growth prospects and policy considerations that may diverge even more in 2013.                                     

We expect ASEAN‟s growth to slow only moderately in 2013 after displaying notable resilience                                      Lavanya Venkateswaran
                                                                                                                                  +91 22 3053 3053
this year to the volatile external environment.1 We forecast GDP growth for the region at 5.4% in                       
2012, before slowing only modestly to 5.1% in 2013. The resilience in 2012 was across the
                                                                                                                                  Nuchjarin Panarode,
board, and manifest itself even in the relatively open economies (Figure 27). However, we see
                                                                                                                                  CNS Thailand
greater differentiation in 2013, and in some cases, the contrasts will be increasingly stark.                                     +662 638 5791

Indonesia and the Philippines: diverging momentum on reforms
We believe the domestically oriented economies of Indonesia and the Philippines will still lead
the pack and forecast 2013 GDP growth for both at 6% or more. However, this belies a key
distinction between the two: the Philippines is on a path toward a higher growth potential while
Indonesia is likely to underperform its medium-term growth target of 7% by 2014. The reason:
the momentum of structural reforms will likely remain strong in the Philippines but we judge it to
be waning in Indonesia. We expect the Philippines to progress into the next phase of fiscal
reforms, starting with the passage of the all important „sin‟ tax bill. The Aquino administration
has shown a strong commitment to pursue these reforms and, importantly, continues to have
the political capital to succeed (see Still strong approval ratings…, 12 November 2012).
Business sentiment has been buoyant, and as a result, we expect a virtuous investment cycle,
where reforms, investment, growth and confidence interact positively with each other.

In Indonesia, the political environment will likely heat up next year, ahead of the 2014 elections,
and we see the rising risk of a policy impasse, or worse, more nationalist/populist regulations
that could further restrict investment (see Asia Special Report: Indonesia: Policy swings, 2
August 2012). This is likely to add pressure to Indonesia‟s already weakening external position
and hence a headwind to Indonesia‟s quest for an investment grade rating at all three agencies
(S&P is still one notch below despite having a „positive‟ outlook since April 2011). Indonesia‟s
current account has turned to a deficit, causing a noticeable decline in its basic balance, which
could deteriorate further if FDI inflows start to slow (Figure 28). In the Philippines, by contrast,
given the durable current account surplus and the prospect of solid FDI inflows, we believe
market expectations of a sovereign credit rating upgrade to investment grade are likely to rise
sharply in 2013. Our credit research team believes an upgrade could come through as early as
H2 2013.

Fig. 27: Investment spending in ASEAN economies                                         Fig. 28: Basic balance (current account balance + net FDI)

    % y-o-y                   Less export oriented                                         USDbn                    Indonesia
    20                        Export oriented                                               8                       Philippines
     15                                                                                    6
     10                                                                                    4
      5                                                                                    2
      0                                                                                    0
     -5                                                                                    -2
    -10                                                                                    -4
    -15                                                                                    -6
      Jun-05 Jun-06 Jun-07 Jun-08 Jun-09 Jun-10 Jun-11 Jun-12                               Sep-05 Sep-06 Sep-07 Sep-08 Sep-09 Sep-10 Sep-11 Sep-12
Source: CEIC, Nomura Global Economics.                                                  Source: CEIC, Nomura Global Economics.

Singapore, Thailand, Malaysia: varying degrees of cyclical policy support
Among the more open ASEAN economies, the external environment will obviously remain a key
drag, but the economies that have the ability to maintain policy support to shore up domestic
demand will likely outperform, which we have already started to see in H2 2012.

    ASEAN refers to the five countries in our coverage: Indonesia, Malaysia, Philippines, Singapore and Thailand.

Nomura | Asia Special Report                                                                                      28 November 2012

Thailand stands out as having both the space and the sense of urgency to maintain very loose
monetary and fiscal policies following the 2011 floods. The Bank of Thailand has already cut its
policy rate by a total 75bp to 2.75%, but there is still room to reduce it further particularly if
exports remain depressed. More importantly, public debt, at 44.2% of GDP, is well below the
government‟s 60% ceiling. There is scope for the government to ramp up spending, particularly
infrastructure, and in the process crowd in more private investment that already benefits from
highly accommodative monetary policy and the post-flood recovery (see Asia Anchor Report:
Thailand: new growth engines, 24 September 2012). We forecast Thailand‟s GDP growth at a
solid 4.5% in 2013 from an average of 2.8% in 2011-12.

In contrast, Singapore is more constrained, and as long as our baseline „no heart attack‟
scenario for the global economy holds, we see few reasons to expect countercyclical policies.
The Monetary Authority of Singapore (MAS) is likely to remain focused on inflation, which is still
at historically high levels driven not only by accommodation costs and car prices but also by
wage pressures as a result of government policies. The government remains steadfast in its
resolve to restructure the economy toward one that is more productivity-driven and less reliant
on foreign labor. Two years into this restructuring agenda, productivity growth continues to
decline but policies that tighten the supply of workers are well underway. So the transition will
clearly take time and the economy will have to endure a low growth, high-inflation environment
in the short term until productivity increases are achieved to offset the decline in labor supply.
We therefore revised down our 2013 growth forecast to 2.4%, which is only a modest
improvement from growth of 1.8% in 2012, to reflect a slowdown in investment spending that is
increasingly dampened by external uncertainty and tight domestic policies.

Malaysia should fall somewhere in between Thailand and Singapore. Fiscal stimulus has been
the main lever through which domestic demand has been supported, while monetary policy has
remained on hold. Bank Negara (BNM) remains cautious, as lowering rates risks increasing
domestic financial imbalances and stoking already high debt levels. In our view, however, the
fiscal expansion is about to run its course – after the elections, which we expect in March, the
government will have to return quickly to its medium-term fiscal consolidation target, adding to
the external drag in H2 that we see intensifying as China slows. That said, the fiscal belt-
tightening will not be accompanied by an unwinding of other government-led initiatives. Projects
under the Economic Transformation Program (ETP) are already underway and will likely
continue to be implemented in 2013. It is for this reason that we have modestly raised our 2013
forecast to 4.3% from 4.0%, despite fiscal and external headwinds.

In sum, our GDP growth forecasts are below consensus in Malaysia and Singapore but above
consensus in Thailand, where we think the powerful forces underpinning private consumption
and investment spending are still underappreciated (Figure 29).

Fig. 29: Consensus and Nomura GDP estimates of open economies in ASEAN

 6                                                  Consensus        Nomura

     GDP (% y-o-y) PCE, ppt   GFCF, ppt GDP (% y-o-y) PCE, ppt    GFCF, ppt GDP (% y-o-y) PCE, ppt    GFCF, ppt
                   Malaysia                           Singapore                            Thailand

Source: Consensus Economics November 2012; Nomura Global Economics.

Upside inflation risks call for interest rate hikes in H2
Inflation is still relatively benign but we expect it to rise in 2013, in some cases to the top end of
official target ranges. Across the region, we see the balance of risks as tilted to the upside for
varying reasons, including positive output gaps (Philippines, Thailand), some food and energy
subsidy adjustments (Indonesia, Malaysia) and tight labor markets (Singapore). Minimum

Nomura | Asia Special Report                                                                             28 November 2012

wages have been raised substantially in Indonesia (by 44% in Jakarta), Thailand and Malaysia,
which could stoke inflation expectations going into 2013. In response, monetary tightening will
likely begin next year. We see policy rate hikes starting in Q3 in Indonesia, Malaysia and the
Philippines. The pace and extent of the tightening should, however, be gradual, as central
banks continue to keep an eye on external risks.

In addition, the risk of excessive capital inflows could complicate monetary policy and limit the
scope for interest rate hikes. As we argued previously (see The case for capital controls in Asia,
1 November 2010), it is not only growth differentials – which are clearly still wide in Asia relative
to developed markets – that drive capital inflows, but also interest rate differentials. In this
context, we also expect the implementation of further macroprudential measures, which has
thus far been the preferred tool among ASEAN central banks to address asset price pressures
that could be exacerbated by large capital inflows. We do not see potential for any drastic
measures (i.e., broad-based capital controls), as central banks have already learned that these
tend to be counterproductive. In addition, although similar pressures occurred in 2010, the
circumstances are very different, especially among the vulnerable countries. Indonesia has
shifted from a current account surplus to a deficit and will therefore be careful not to drive away
foreign capital that help finance this deficit. In Thailand, we feel the authorities are more tolerant
of a stronger currency as it helps support the ongoing upgrade of productive capacity (which
entails higher importation requirements) following the devastating floods in 2011.

Fig. 30: CPI inflation in ASEAN

  %y-o-y            Indonesia             Malaysia
                    Philippines           Singapore          Nomura forecasts
   Mar-08 Oct-08 May-09 Dec-09 Jul-10 Feb-11 Sep-11 Apr-12 Nov-12 Jun-13

Source: CEIC: Nomura Global Economics estimates.

Nomura | Asia Special Report                                                                                                        28 November 2012

Forecast summary

                                                  Real GDP                                              Consumer Prices
                                2012              2013               2014               2012             2013                  2014
 China                            7.9               7.7                7.5                 2.6                4.2                4.0
 Hong Kong                        1.2               2.5                3.5                 4.0                4.3                4.3
 India*                           5.3               6.1                6.5                 7.6                7.2                6.9
 Indonesia                        6.1               6.1                6.2                 4.4                5.2                5.1
 Malaysia                         5.3               4.3                4.6                 1.7                2.4                2.5
 Philippines                      6.6               6.4                5.8                 3.2                4.6                4.5
 Singapore                        1.8               2.4                4.2                 4.8                3.9                3.6
 South Korea                      2.3               2.5                3.5                 2.2                2.7                3.0
 Taiwan                           1.0               3.0                3.5                 2.0                2.3                2.3
 Thailand                         5.5               4.5                5.0                 3.0                3.0                3.1
 Asia ex-Japan                     6.3              6.4              6.6               3.7                    4.6                4.5
 Note: * CPI refers to wholesale prices. Source: CEIC, Bloomberg, Nomura Global Economics.

                                        Current Account (% of GDP)                                  Fiscal Balance (% of GDP)
                                2012             2013            2014                   2012               2013             2014
 China                            1.7               1.0               -0.4                 -1.5              -1.5               -1.6
 Hong Kong                        1.9              -0.9               -2.5                 -0.2              -0.5               -0.5
 India                           -4.2              -3.8               -3.4                 -5.8              -5.2               -5.0
 Indonesia                       -2.2              -1.9               -1.6                 -2.4              -2.0               -2.2
 Malaysia                         5.9               4.7                4.2                 -4.9              -4.5               -4.2
 Philippines                      2.5               1.9                1.7                 -2.2              -2.6               -2.2
 Singapore                      15.7               16.1               17.0                 0.2               -0.2                0.4
 South Korea                      3.3               2.3                2.0                 1.3                1.0                1.0
 Taiwan                           9.1               7.9                7.4                 -1.8              -1.9               -2.0
 Thailand                         0.7              -0.7               -0.7                 -2.5              -3.5               -3.7
 Asia ex-Japan                     0.9                 0.4               -0.3               -2.3               -2.2               -2.3
 Note: Fiscal balances are for fiscal years which differ from calendar years for Hong Kong (Apr-Mar), India (Apr-Mar), Singapore (Apr-Mar) and
 Thailand (Oct-Sep). Fiscal data are for the central government and do not include off-budget. Source: CEIC, Bloomberg, Nomura Global

                                             Official Policy Rate                                    Currency per US Dollar
                                2012              2013               2014                 2012             2013             2014
 China                          6.00               6.50               6.50                6.26               6.15               6.14
 Hong Kong                      0.40               0.40               0.40                7.75               7.75               7.75
 India                          8.00               7.50               7.00                54.0               59.0               56.0
 Indonesia                      5.75               6.25               6.75                9620              9800               9600
 Malaysia                       3.00               3.50               4.00                3.02               2.92               2.84
 Philippines                    3.50               4.00               4.50                40.6               39.2               38.2
 Singapore                      0.38               0.48               0.50                1.22               1.19               1.17
 South Korea                    2.75               2.75               3.25                1080              1050               1040
 Taiwan                         1.88               2.13               2.13                29.0               28.7               28.2
 Thailand                          2.75                2.75                3.25               30.5            29.9             29.2
 Note: All figures relate to the modal forecast, ie, the "most likely" outcome. Source: CEIC, Bloomberg, Nomura Global Economics.
 The ↑↓ arrows signify changes from last week.

Source: CEIC, Nomura Global Economics.

Nomura | Asia Special Report                                                                                               28 November 2012

Economic outlook
China: Up in H1, down in H2

We expect economic growth to be driven by cyclical policies since progress on                                Zhiwei Zhang
                                                                                                             +852 2536 7433
structural reforms may be slow.                                                                    

Activity: We expect GDP growth to recover strongly to above 8% y-o-y in H1 2013, then slow in                Wendy Chen
                                                                                                             +86 21 6193 7237
H2 toward 7% by Q4 2013. Fixed asset investment should be a main driver of the H1 recovery.        
Infrastructure investment has already picked up strongly from policy easing, and its momentum
will very likely continue in H1 2013. Housing investment growth should pick up moderately in H1
2013 after falling over the first three quarters of 2012. Given that a recovery in H1 would be
driven by countercyclical policy easing and not an improvement in economic fundamentals,
GDP growth should return to its potential rate in H2 2013, when policy easing ends.

Inflation: Inflation should rise to above 4% y-o-y by mid-2013 for two reasons: 1) Headline GDP
growth will be pushed above 8% y-o-y by policy easing in H1. This should result in the
emergence of a positive output gap and lead to inflationary pressures. 2) Global commodity
prices have rebounded recently and will likely push up production costs in 2013.

Policy: 2013 is the first year of new leadership in China. We think that progress on reforms will
likely be slow in 2013, as the new leaders will need time to build the political capital required to
push through tough reforms. On monetary policy, the People‟s Bank of China stated that, “The
economy has changed to be less sensitive to the constraint imposed by employment, but more
sensitive to constraint imposed by inflation” in its Q3 monetary policy statement, which suggests
that it is more concerned with inflation than growth. We expect two rate hikes in H2 when
inflation rises above 4%.

Risks: We see three key risks to our forecast. The first and most important is policy uncertainty,
as there could be political pressures to maintain the loose policy stance longer than we expect.
The second risk is inflation, which may return at a slower pace and delay policy easing. The
third risk is the global economy, as there is still uncertainty over economic conditions in Europe.

Details of the forecast
 % y-o-y growth unless otherwise stated        1Q12    2Q12     3Q12    4Q12     1Q13    2Q13     3Q13    4Q13     2012     2013     2014
 Real GDP                                        8.1      7.6     7.4      8.4     8.4      8.0     7.4     7.0      7.9      7.7      7.5

 Consumer prices                                 3.8      2.9     1.9      2.0     2.8      3.7     4.6     5.6      2.6      4.2      4.0
  Core CPI                                       1.5      1.3     1.5      1.8     2.0      2.1     2.4     2.1      1.5      2.2      2.0

 Retail sales (nominal)                         14.9    13.9     13.5    15.0     16.2    15.9     15.5    15.6     14.3     15.8    16.0
 Fixed-asset investment (nominal, ytd)          20.9    20.4     20.5    21.0     20.8    21.2     21.3    22.0     21.0     22.0    20.0
 Industrial production (real)                   11.6      9.5     9.1    12.0     10.9    10.7     10.5    10.3     10.6     10.6    10.5

 Exports (value)                                 7.6    10.5      4.5      5.0     3.0      4.0     6.0     6.0      6.8      4.8      6.0
 Imports (value)                                 6.9      6.5     1.4      9.0     7.0      8.0     9.0     9.0      6.0      8.3    10.0
 Trade surplus (US$bn)                           1.1    68.8     79.5    32.1    -16.0    53.4     70.4    19.1    181.5    126.9    54.5
 Current account (% of GDP)                                                                                          1.7      1.0      -0.4
 Fiscal balance (% of GDP)                                                                                          -1.5     -1.5      -1.6

 New increased RMB loans (CNYtrn)                                                                                    8.0      9.0      9.0
 1-yr bank lending rate (%)                     6.56    6.31     6.00    6.00     6.00    6.00     6.25    6.50     6.00     6.50    6.50
 1-yr bank deposit rate (%)                     3.50    3.25     3.00    3.00     3.00    3.00     3.25    3.50     3.00     3.50    3.50
 Reserve requirement ratio (%)                  20.5    20.0     20.0    19.5     19.5    19.5     19.5    19.5     19.5     19.5    18.5
 Exchange rate (CNY/USD)                        6.29    6.35     6.28    6.26     6.22    6.18     6.16    6.15     6.26     6.15    6.14
Notes: Numbers in bold are actual values; others forecast. Interest rate and currency forecasts are end of period; other measures are
period average. The CNY/USD forecast is for the fixing rate, not the spot rate. All forecasts are modal forecasts (i.e., the single most
likely outcome). Table reflects data available as of 28 November 2012.
Source: CEIC and Nomura Global Economics

Nomura | Asia Special Report                                                                                              28 November 2012

Hong Kong: Looming fiscal stimulus

We expect an expansionary FY13 budget given weak external demand.                                            Young Sun Kwon
                                                                                                             +852 2536 7430
Activity: Retail sales growth volume increased by 8.5% y-o-y in September from 3.2% in
August while the PMI rose to 50.5 from 49.6. We expect private consumption to remain robust,                 Aman Mohunta
                                                                                                             +91 22 6617 5595
supported by a tight labour market, positive wealth effects from buoyant property prices and       
increasing visitor numbers. Further, domestic fixed asset investment should remain strong
supported by infrastructure works. We expect fiscal stimulus and a moderate improvement in
external demand to lift real GDP growth from 1.2% in 2012 to 2.5% in 2013. A modest recovery
in the global economy should boost GDP growth further to 3.5% in 2014.

Inflation: CPI inflation ticked up to 3.8% y-o-y in September from 3.7% in October on food
prices. Inflation should rise through 2013, driven by higher food, fuel and rent prices, only partly
offset by inflation-mitigating fiscal measures such as a temporary waiver of public housing rent
and electricity subsidies. We expect CPI inflation to rise from 4.0% in 2012 to 4.3% in 2013.

Policy: Hong Kong's fiscal policy is expansionary as the budget for FY12 (year starting April)
includes not only inflation-mitigating measures but also an income tax reduction for individuals
of up to HKD12,000 per person and a 14.8% increase in capital expenditure. This should
continue to help stabilise inflation and support the job market. We expect the FY13 budget to
also be expansionary given that external demand remains weak. We would also expect the
government to continue implementing more macro-prudential property tightening measures,
such as hikes in stamp duty if house prices continue to rise, although so far these piecemeal
measures have had limited success in cooling the property market. Because of the USD/HKD
peg, Hong Kong is importing the super loose monetary policy of the US, and it remains unclear
whether tighter macro-prudential measures can provide a sufficient offset in the long run.

Risks: As a small, open economy and financial hub, Hong Kong is one of the most vulnerable
in Asia to weakness in the global economic outlook. An economic hard-landing in China would
be especially detrimental through both trade and financial channels.

Details of the forecast
 % y-o-y growth unless otherwise stated        1Q12    2Q12     3Q12    4Q12     1Q13    2Q13    3Q13     4Q13    2012     2013    2014
 Real GDP (sa, % q-o-q, annualised)              2.1    -0.2      2.5     2.7      3.1     1.3     4.0      1.7
 Real GDP                                        0.7     1.2      1.3     1.7      2.0     2.5     2.8      2.5     1.2      2.5     3.5
  Private consumption                            6.4     3.1      2.8     4.5      3.2     3.4     3.6      4.5     4.2      3.7     4.4
  Government consumption                         2.5     3.5      3.7     3.2      3.5     3.7     3.8      4.2     3.2      3.8     4.4
  Gross fixed capital formation                 12.6     5.7      8.7     6.0      5.8     5.8     5.7      5.8     8.1      5.8     6.1
  Exports (goods & services)                     1.4     5.5      8.7     1.9      4.5     5.0     5.0      5.5     4.4      5.0     7.2
  Imports (goods & services)                     4.2     0.9     10.7     3.0      5.1     5.5     6.2      6.9     6.2      5.9     7.7
 Contributions to GDP (% points)
  Domestic final sales                           7.4      3.7     4.3      4.7     3.8     4.0      4.2     4.8     5.0      4.2     4.8
  Inventories                                   -1.8     -1.4    -1.1     -0.6    -0.7    -0.3      1.1     0.6    -1.2      0.2    -0.2
  Net trade (goods & services)                  -5.4     -3.2    -3.3     -2.2    -1.0    -1.3     -2.3    -2.7    -3.5     -1.9    -1.1
 Unemployment rate (sa, %)                       3.4      3.3     3.5      3.4     3.4     3.4      3.4     3.4     3.4      3.4     3.2
 Consumer prices                                 5.2      4.2     3.1      3.6     3.7     4.3      4.5     4.6     4.0      4.3     4.3
 Exports                                        -1.2      2.0     4.4      7.0     9.2    10.4     10.1    10.4     3.1     10.0    12.3
 Imports                                         0.9      2.3     5.0      8.0     9.5    10.5     10.9    11.7     4.1     10.7    12.5
 Trade balance (US$bn)                         -12.7    -15.9   -15.6    -17.2   -14.2   -17.6    -18.3   -20.8   -61.4    -71.0   -80.7
 Current account balance (% of GDP)                                                                                 1.9     -0.9    -2.5
 Fiscal balance (% of GDP)                                                                                         -0.2     -0.5    -0.5
 3-month Hibor (%)                              0.40     0.40    0.40    0.40     0.40    0.40    0.40     0.40    0.40     0.40    0.40
 Exchange rate (HKD/USD)                        7.76     7.76    7.75    7.75     7.75    7.75    7.75     7.75    7.75     7.75    7.75

Source: Numbers in bold are actual values; others forecast. Interest rate and currency forecasts are end of period; other measures are
period average. All forecasts are modal forecasts (i.e., the single most likely outcome). Table reflects data available as of 28 November
2012. Source: CEIC and Nomura Global Economics.

Nomura | Asia Special Report                                                                                                  28 November 2012

India: A year of consolidation

With macro imbalances slow to correct, binding supply-side constraints and weak                                   Sonal Varma
                                                                                                                  +91 22 403 74087
global demand, a quick rebound is unlikely. We expect a shallow growth recovery.                        

                                                                                                                  Aman Mohunta
                                                                                                                  +91 22 6617 5595
Activity: Despite GDP growth falling to a 10-year low of 5.3% in 2012, we believe there will be         
a shallow recovery, with growth rising to 6.1% in 2013, for three reasons. First, we expect
growth in Western economies to remain weak in 2013. Second, as potential growth has fallen to
6.5-7.0%, the output gap will close quickly on any demand pick-up, pushing up core inflation
and limiting the extent of monetary easing. Third, the number of new capex projects is unlikely
to increase due to a higher cost of capital, an uncertain demand outlook and the lagged impact/
implementation risks of the reforms that have been announced so far. We expect only existing
shelved investments to be revived if land, coal and environmental issues are resolved.

Inflation and trade: With sub-potential growth, we expect WPI inflation to moderate from an
estimated 7.6% in 2012 to a still-high 7.2% in 2013. Core inflation should moderate in H1 2013
because of the negative output gap, but we expect INR depreciation and a narrowing output
gap to push core inflation up again in H2 2013. With binding supply-side constraints and high
food inflation, we do not expect headline and core inflation to sustain levels below 7% and 5%,
respectively. We expect high inflation to reduce India‟s export competitiveness and imports to
remain elevated from domestic supply side constraints. Hence, we expect the current account
deficit to remain high at 3.8% of GDP in 2013 from an estimated 4.2% in 2012.

Policy: We expect the Reserve Bank of India to reduce the repo rate by 50bp in H1 2013 on
lower core inflation. However, with headline inflation likely to remain in a 7.0-7.5% range in 2013
and core inflation likely to accelerate again in 2H 2013, policy rates will likely remain on hold in
2H. We also expect the fiscal deficit to remain above 5% of GDP in FY14 (year ending March
2014) due to slow growth and an inability to cut subsidies ahead of the elections in 2014.

Risks: A sharp rise in oil prices, a deeper and prolonged global slowdown and weather-related
shocks are the key downside risks. Lower commodity prices, a stronger than expected global
recovery and a quick investment revival are upside risks.

Details of the forecast
 % y-o-y growth unless otherwise stated                1Q12     2Q12    3Q12     4Q12    1Q13     2Q13    3Q13      4Q13    2012   2013     2014
 Real GDP (sa, % q-o-q, annualised)                      5.9     5.3      5.2     5.8      6.8     5.9      6.2      6.8
 Real GDP                                                5.3     5.5      5.4     5.3      5.9     6.0      6.1      6.4     5.3    6.1     6.5
  Private consumption                                    6.1     4.0      4.2     3.4      4.0     4.6      3.7      5.8     4.4    4.6     5.3
  Government consumption                                 4.1     9.0      4.0     5.0      5.1     5.5      6.5      7.0     5.4    6.0     6.2
  Fixed investment                                       3.6     0.7      3.6     4.5      6.2     7.0      6.5      6.0     3.1    6.4     6.6
  Exports (goods & services)                            18.1    10.1      5.5     7.0      7.4     7.6      8.4      8.6    10.4    8.0     9.9
  Imports (goods & services)                             2.0     7.9      6.5     5.0      6.0     7.2      6.0      5.7     5.4    6.2     8.6
 Contributions to GDP (% points)
  Domestic final sales                                   1.3     5.7      6.3     5.2      5.4     6.3      6.1      6.2     4.6    6.0     6.6
  Inventories                                            0.0     0.0      0.1     0.1      0.0     0.1      0.2      0.1     0.0    0.1     0.2
  Net trade                                              4.0     -0.2    -1.0     -0.1     0.4     -0.5    -0.1      0.1     0.8    0.0     -0.3
 Wholesale price index                                   7.5     7.5      7.8     7.7      7.4     7.0      7.1      7.3     7.6    7.2     6.9
 Consumer prices                                         7.2    10.1      9.8    10.1     10.5     9.8      9.7      9.3     9.3    9.8     9.2
 Current account balance (% GDP)                                                                                            -4.2    -3.8    -3.4
 Fiscal balance (% GDP)                                                                                                     -5.8    -5.2    -5.0
 Repo rate (%)                                          8.50    8.00     8.00    8.00     7.75    7.50     7.50     7.50    8.00    7.50    7.00
 Reverse repo rate (%)                                  7.50    7.00     7.00    7.00     6.75    6.50     6.50     6.50    7.00    6.50    6.00
 Cash reserve ratio (%)                                 4.75    4.75     4.50    4.25     4.00    4.00     4.00     4.00    4.25    4.00    4.75
 10-year bond yield (%)                                 8.54    8.18     8.15    8.10     7.80    7.80     7.70     7.50    8.10    7.50    7.00
 Exchange rate (INR/USD)                                51.2    54.0     52.7    54.0     54.5    56.0     60.0     59.0    54.0    59.0    56.0

Notes: Numbers in bold are actual values; others forecast. Interest rate and currency forecasts are end of period; other measures are
period average. CPI is for industrial workers. Fiscal deficit is for the central government and for fiscal year, e.g, 2012 is for the year ending
March 2013. Table reflects data available as of 28 November 2012. Source: CEIC and Nomura Global Economics.

Nomura | Asia Special Report                                                                                             28 November 2012

Indonesia: Watch policies and politics

The policy environment is likely to remain challenging ahead of the 2014 elections.                        Euben Paracuelles
                                                                                                           +65 6433 6956
Activity: We expect GDP growth to remain stable at 6.1% in 2013, driven mainly by resilient
domestic demand. Growth in investment spending will likely moderate but that of private                    Lavanya Venkateswaran
                                                                                                           +91 22 3053 3053
consumption should remain stable. Government expenditures should also contribute more            
positively ahead of the 2014 elections, as implementation of the budget improves, particularly
on infrastructure (as opposed to this year‟s under-spending). The risk of nationalist and populist
policies is also likely to increase in 2013 as the incumbents focus on the 2014 parliamentary
and presidential elections. On the external front, we believe the current account deficit will likely
narrow in 2013 supported by higher export growth to China in H1, and improving US and EU
growth in H2. However, as we approach 2014, the uncertain policy environment could add to
concerns over FDI inflows (see Asia Special Report: Indonesia: Policy swings, August 2012),
affecting the balance of payments, and in turn pressuring IDR.
Inflation and monetary policy: We expect CPI inflation to rise to 5.2% y-o-y in 2013 from an
estimated 4.4% this year, driven by core inflation and supply-side factors such as the upward
adjustments of electricity tariffs (approximately 4% each quarter). The large minimum wage
increases to be implemented in 2013 pose further upside risks to inflation and inflation
expectations. For these reasons we expect Bank Indonesia (BI) to maintain its tightening bias
and eventually hike the policy rate by a cumulative 50bp in H2 2013. In the interim, it is likely
that BI will introduce administrative and macro-prudential measures if domestic demand
remains strong and portfolio capital inflows persist.
Fiscal policy: We expect the 2013 fiscal deficit to overshoot the budgeted 1.65% of GDP.
While the approved 2013 budget allows the government to raise fuel prices if deviations from
macroeconomic assumptions occur, we have not factored any changes to fuel subsidy policy
into our baseline forecast because of the elections. Thus, we expect increased operating costs
and subsidies to cause fiscal slippage of close to 0.3pp, resulting in a 2013 deficit of 2% of GDP.
Risks: The key risk for next year is a lack of progress on structural reforms and the
implementation of more protectionist policies ahead of the elections, both of which could
damage already-fragile investor sentiment and slow FDI inflows. A deeper recession in the euro
area, a hard landing in China and large capital flow reversals also pose downside risks.

Details of the forecast
% y-o-y growth unless otherwise stated      1Q12     2Q12    3Q12     4Q12    1Q13     2Q13     3Q13    4Q13     2012      2013     2014
Real GDP (sa, % q-o-q, annualised)
Real GDP                                      6.3      6.4     6.2      5.7      6.1     6.2      6.0     6.0      6.1       6.1     6.2
 Private consumption                          4.9      5.2     5.7      5.6      5.5     5.5      5.6     5.5      5.4       5.5     5.6
 Government consumption                       5.9      7.4    -3.2      5.0      7.0     8.0     10.0    10.0      3.6       9.0     7.0
 Gross fixed capital formation               10.0     12.3    10.0      9.9      9.8     8.9      8.8     7.1     10.5       8.4     9.0
 Exports (goods & services)                   7.9      2.2    -2.8      5.5      6.0     6.0      7.0     8.0      3.1       6.8    10.0
 Imports (goods & services)                   8.0     10.9    -0.5      6.0      6.5     7.0      5.5    14.0      6.0       8.4    11.9
Contributions to GDP (% points)
 Domestic final sales                         5.5      6.4      5.3     6.3      5.7     5.8      6.0     6.1      6.2       6.0      6.0
 Inventories                                  2.0      2.3     -0.1    -1.0      0.0     0.0      0.0     0.2      0.8       0.0     -0.3
 Net trade (goods & services)                 0.7     -3.1     -1.2     0.4      0.4     0.0      1.3    -1.5     -0.8       0.1      0.2
Consumer prices                               3.7      4.5      4.5     4.7      5.0     5.1      5.3     5.4      4.4       5.2      5.1
Exports                                       5.3     -7.6    -13.0     2.8      6.0     9.0      8.0     9.0     -3.6       8.0      8.0
Imports                                      21.4      8.9     -0.3     6.2      7.0     7.0      8.0    10.5      8.8       8.1     14.4
Merchandise trade balance (US$bn)             1.7     -1.3      0.6    -1.1      1.6    -1.1      2.7    -3.5     -0.8      -2.5     -3.3
Current account balance (% of GDP)           -1.5     -3.1     -2.4    -1.6     -1.3    -2.2     -1.8    -2.4     -2.2      -1.9     -1.6
Fiscal Balance (% of GDP)                                                                                         -2.4      -2.0     -2.2
Bank Indonesia rate (%)                       5.75    5.75     5.75    5.75     5.75    5.75     6.25    6.25     5.75      6.25     6.75
Exchange rate (IDR/USD)                      9146    9433     9591    9620     9660    9680     9730    9800     9620      9800     9600
Notes: Numbers in bold are actual values; others forecast. Interest rate and currency forecasts are end of period; other measures are
period average. All forecasts are modal (i.e., the single most likely outcome). Table reflects data available as of 28 November 2012.
Source: CEIC and Nomura Global Economics.

Nomura | Asia Special Report                                                                                             28 November 2012

Malaysia: Time for fiscal tightening

We see significant fiscal consolidation after the elections, adding to the external drag.                   Euben Paracuelles
                                                                                                            +65 6433 6956
Activity: We expect GDP growth to slow to 4.3% in 2013 from 5.3% in 2012 as domestic and
external demand weaken. Fiscal policy has bolstered growth for two years, and as a result,                  Lavanya Venkateswaran
                                                                                                            +91 22 3053 3053
public debt has risen from 39.8% of GDP in 2008 to 51.8% in 2011. This suggests fiscal            
consolidation will have to be significant once the elections are over. In our base case, we expect
it to be held in March (before the April 2013 deadline). That said, new and existing investments
under the Economic Transformation Programme (ETP) should continue to support growth.
External demand will likely remain subdued: as growth remains weak in the US and Europe in
H1 and in China in H2, which would have a bigger impact on commodity exporters like Malaysia.

Inflation and monetary policy: We estimate headline CPI inflation will average 2.4% in 2013
higher than 1.7% in 2012 due to factors such as minimum wage hikes, higher cost push
pressures, and modest subsidy adjustments (e.g. sugar). Against this backdrop, we continue to
expect Bank Negara Malaysia (BNM) to stay on hold throughout H1 2013, before hiking its
policy rate by 50bp in H2 2013. In our view another key policy consideration is the risk from
keeping rates low for too long, fueling an excessive build-up of public and household debt levels.
Hence we judge BNM‟s bias is still to normalise rates, but make the adjustment gradual. We
expect a total of 50bp hikes next year, taking the policy rate to its pre-crisis level of 3.50%.

Fiscal policy and political outlook: The 2013 budget aims to reduce the fiscal deficit to 4.0%
of GDP from 4.5% in 2012 and suggests the government recognises the need to get its
medium-term fiscal consolidation plans back on track. Nonetheless, we think this is ambitious
because this implies a negative fiscal impulse and is based on high GDP growth assumptions
(4.5-5.5%). We forecast the fiscal deficit at 4.5% of GDP as a result. In terms of the political
outlook, we think the elections in March will result in a win by Barisan Nasional, but with a
smaller majority (see Asia Insights: The Malaysian general election revisited, 8 November 2012).
This should still bode well for the resumption of structural reforms.

Risks: With exports nearly 100% of GDP, a sharp drop in commodity prices and another global
recession is the biggest downside risk. A weaker-than-expected coalition or a win by the
opposition would raise questions about the political transition and the reform agenda.

Details of the forecast
% y-o-y growth unless otherwise stated      1Q12     2Q12    3Q12     4Q12    1Q13    2Q13     3Q13    4Q13     2012    2013     2014
Real GDP                                      5.1      5.6     5.2      5.1     4.9     4.6      4.0     3.9      5.3     4.3      4.6
 Private consumption                          7.4      8.8     8.5      7.7     9.2     6.8      6.1     6.1      8.1     7.0      5.5
 Government consumption                       9.1     10.9     2.3     10.0     9.0     6.6      6.3     3.6      8.2     5.9      4.5
 Gross fixed capital formation               16.2     26.1    22.7     18.1    13.1    12.8     11.0    10.0     20.8    11.7      6.8
 Exports (goods & services)                   2.8      2.1    -3.0     -0.4     1.4     2.2      1.7     2.8      0.3     2.0      7.2
 Imports (goods & services)                   6.8      8.1     4.4      5.1     6.1     4.9      6.2     4.8      6.1     5.5      8.5
Contributions to GDP (% points)
 Domestic final sales                          8.3    11.8      9.8    10.0     9.0     7.8      6.9     6.5    10.0      7.5     5.5
 Inventories                                  -0.2    -1.2      2.2     0.0    -0.1    -1.0      0.9    -1.0     0.2     -0.3     0.0
 Net trade (goods & services)                 -3.1    -4.9     -6.8    -5.0    -3.9    -2.3     -3.8    -1.6    -5.0     -2.9    -0.8
Unemployment rate (%)                          3.0     3.0      3.0     3.2     3.3     3.3      3.4     3.4     3.0      3.4     3.4
Consumer prices                                2.3     1.7      1.4     1.5     2.1     2.6      2.5     2.5     1.7      2.4     2.5
Exports                                        3.3    -0.3     -4.7     8.2     4.6     7.3      6.9     5.6     1.6      6.1     8.4
Imports                                        6.2     5.5      3.9     9.2     8.8    10.0     11.7     7.7     6.2      9.5    13.1
Merchandise trade balance (USD bn)             9.7     6.8      5.5    10.6     8.2     6.0      3.5    10.1    32.7     27.8    19.9
Current account balance (% of GDP)             8.0     4.1      4.0     7.5     5.0     4.8      2.0     6.0     5.9      4.7     4.2
Fiscal Balance (% of GDP)                                                                                       -4.9     -4.5    -4.2
Overnight policy rate (%)                    3.00     3.00    3.00     3.00    3.00    3.00     3.25    3.50    3.00     3.50    4.00
Exchange rate (MYR/USD)                      3.06     3.18    3.06     3.02    2.97    2.95     2.93    2.92    3.02     2.92    2.84
Note: Numbers in bold are actual values; others forecast. Interest rate and currency forecasts are end of period; other measures are
period average. All forecasts are modal forecasts (i.e., the single most likely outcome). Table reflects data available as 28 November
2012. Source: CEIC and Nomura Global Economics.

Nomura | Asia Special Report                                                                                               28 November 2012

Philippines: Still likely to shine

Given the momentum of reform, investment is set to become a bigger growth driver.                             Euben Paracuelles
                                                                                                              +65 6433 6956
Activity: We forecast 2013 GDP growth at an above-potential 6.4%, driven by more progress in
infrastructure projects under the public-private partnership (PPP) scheme and higher fiscal                   Lavanya Venkateswaran
                                                                                                              +91 22 3053 3053
spending ahead of the mid-term elections in May 2013. We expect private consumption to              
remain robust with resilient remittances and buoyant consumer sentiment. But we see more
notable improvement in investment spending, which reflects the lagged effects from significant
monetary easing this year but also the strength of business sentiment from governance reforms.
As a result, investment-led domestic demand should fully offset the weakness in exports.

Inflation and monetary policy: We expect CPI inflation to rise to 4.6% in 2013 from 3.2% in
2012, as demand side pressures strengthen. This is still within the Bangko Sentral ng Pilipinas
(BSP) 3-5% target but risks are to the upside with above-trend growth and measures pending
such as legislation to increase taxes on „sin‟ products (i.e., alcohol and tobacco). Therefore, we
expect BSP to keep its policy rate unchanged at 3.5% for the rest of 2012 and throughout H1
2013, before hiking it gradually in Q3 2013. Large capital inflows will remain a key consideration
in BSP‟s policymaking and as such, the risk of more administrative and macro-prudential
measures is likely to remain high.

Fiscal policy: We expect the fiscal deficit to widen to 2.6% of GDP from 2.2% this year given
the mid-term elections and the strong bias to use the available fiscal space to improve the pace
and quality of spending. Gross government debt has fallen from 70.5% of GDP in 2006 to 56%,
and we expect more progress on fiscal policy reforms to broaden the tax base and improve tax
collections (e.g., the „sin‟ tax bill is likely to be passed soon) which will put the country‟s
sovereign credit rating on track for an upgrade to investment grade within the next two years.

Risks: The main risk to our forecast is an external shock from Europe and the US fiscal cliff.
Slower progress on reforms and infrastructure spending could also hurt growth. We see the
elections as a non-event because the status quo will likely be maintained, but it could
temporarily disrupt the legislation of fiscal reforms and the bidding out of infrastructure projects.

Details of the forecast
% y-o-y growth unless otherwise stated          1Q12    2Q12     3Q12     4Q12     1Q13     2Q13     3Q13     4Q13     2012     2013     2014
Real GDP (sa, % q-o-q, annualised)               10.5      5.2      5.5      6.6      9.8      4.0      4.4      6.8
Real GDP                                          6.3      6.0      7.1      6.9      6.7      6.4      6.2      6.2     6.6      6.4      5.8
 Private consumption                              5.1      5.9      6.2      6.5      6.7      6.8      6.1      5.9     6.0      6.3      5.8
 Government consumption                          20.9      6.8     12.0     15.8     10.0     11.6      7.0      9.6    13.3      9.7      8.0
 Gross fixed capital formation                    3.9     11.8      8.7     10.6     10.9     10.8     15.8     15.3     8.6     13.2     14.5
 Exports (goods & services)                      10.9      8.3      6.9      8.4      6.8      7.0      7.3      6.1     8.6      6.8      9.0
 Imports (goods & services)                      -3.2     10.3      8.3      7.6     16.4     11.2     12.6      8.9     5.8     12.2     13.0
Contribution to GDP growth (% points)
 Domestic final sales                             6.4      7.0      7.2      8.2      8.2      8.1      8.1      8.2      7.2      8.1      8.1
 Inventories                                     -7.2     -0.2      0.5     -0.9      2.8      1.2      0.8     -0.3     -1.8      0.9      0.0
 Net trade (goods & services)                     7.1     -0.8     -0.7     -0.4     -4.3     -2.1     -2.7     -1.7      1.2     -2.6     -2.3
Exports                                           4.8     10.5      6.2      8.4      6.8      7.0      7.3      6.1      7.5      6.8      9.0
Imports                                          -1.5      2.2      0.8     12.0     14.2     11.2     12.6      8.9      3.3     11.7     13.0
Merchandise trade balance (US$bn)                -2.6     -1.4     -2.0     -4.6     -4.0     -2.1     -2.9     -5.3    -10.6    -14.3    -18.4
Current account balance (US$bn)                   0.8      2.8      2.1      0.4      0.5      2.6      0.7      1.7      6.2      5.6      5.5
Current account balance (% of GDP)                1.5      4.6      3.4      0.6      0.9      3.8      1.0      2.0      2.5      1.9      1.7
Fiscal balance (% of GDP)                                                                                                -2.2     -2.6     -2.2
Consumer prices (2006=100)                        3.1      2.9      3.5      3.4      4.2      4.6      4.7      4.9      3.2      4.6      4.5
Unemployment rate (sa, %)                         6.9      7.0      7.5      7.0      6.8      6.8      6.5      6.5      7.1      6.7      6.5
Reverse repo rate (%)                            4.00     4.00     3.75     3.50     3.50     3.50     3.75     4.00     3.50     4.00     4.50
Exchange rate (PHP/USD)                          42.9     42.1     41.7     40.6     40.2     39.8     39.6     39.2     40.6     39.2     38.2

Notes: Numbers in bold are actual values; others forecast. Interest rate and currency forecasts are end of period; other measures are
period average. All forecasts are modal forecasts (i.e., the single most likely outcome). Table reflects data available as of 28 November
2012. Source: CEIC and Nomura Global Economics.

Nomura | Asia Special Report                                                                                                28 November 2012

Singapore: The (long) road to restructuring

The government is rightly sticking to its long-term goal of raising productivity. In the                     Euben Paracuelles
                                                                                                             +65 6433 6956
meantime, the economy will likely endure a low growth, high inflation environment.                 

Activity: In line with official projections of 1.0-3.0% GDP growth, we expect growth to increase             Lavanya Venkateswaran
                                                                                                             +91 22 3053 3053
but remain subpar at 2.4% y-o-y in 2013 from 1.8% in 2012. The improvement should be led by        
                                                                                                             Euben Paracuelles
recovering growth in China in H1, and the EU and US in H2. However, due to the on-going                      +65 6433 6956
efforts to restructure the economy toward productivity-driven growth (which is less reliant on
foreign labor), we expect the government to refrain from stimulus spending. Private investment               Lavanya Venkateswaran
                                                                                                             +91 22 3053 3053
spending will also likely remain weak as business sentiment is affected by external uncertainty    
and tight domestic policies.
Inflation and monetary policy: We expect CPI inflation to remain elevated, averaging 3.9% in
2013 from 4.8% in 2012, led by private transport and accommodation costs. In addition,
underlying inflation should remain sticky as labour markets remain tight and wage pressures
persist. The Monetary Authority of Singapore (MAS) believes there are upside risks from rising
global food prices. The MAS decision to maintain its S$NEER policy in October despite slowing
growth suggests inflation will remain a key concern. In addition, we think this policy decision
complements its longer term economic objectives, as the MAS explicitly stated that the decision
was in line with containing inflationary pressures but also with “keeping the economy on a path
of restructuring towards sustainable growth.”
Fiscal policy: The fiscal stance should remain broadly neutral in 2013 with the government
running a small deficit of 0.2% of GDP from a surplus of 0.2% in 2012. We believe the
government is firmly focused on encouraging the private sector to adopt productivity-enhancing
measures rather than alleviating cyclical external risks. Pressure is mounting from small and
medium enterprises (SMEs) which are asking the government to relax its foreign labor policy,
but the government said there will be “no U-turn”. Instead, it is increasing awareness among
SMEs regarding fiscal schemes that have already been in place to boost productivity but have
seen limited adoption. We also expect higher budget allocations to social spending given the
ageing population and widening income disparity, as well as to upgrading public infrastructure.
Risks: With exports twice its GDP, Singapore is the most vulnerable economy in South-east
Asia to a major contraction in global GDP. Another risk flare up in Europe, the US falling off the
fiscal cliff, or a hard landing in China would hit Singapore hard via knock-on effects from exports
and capital outflows. Another risk is domestic overheating, fueled by low interest rates.

Details of the forecast
% y-o-y growth unless otherwise stated         1Q12     2Q12    3Q12     4Q12    1Q13     2Q13    3Q13     4Q13    2012       2013    2014
Real GDP (sa, % q-o-q, annualised)              10.1      0.5    -5.9      6.9     9.1     -0.5    -5.5      8.3
Real GDP                                         1.6      2.5     0.3      2.7     2.5      2.2     2.3      2.7      1.8       2.4     4.2
 Private consumption                             4.4      1.7     1.1      2.8     4.8      4.2     3.3      3.0      2.5       3.8     3.5
 Government consumption                         -4.2     -1.2    -0.9      3.1     1.8      2.1    -7.1      3.4     -1.1       0.1     4.0
 Gross fixed capital formation                  18.5      4.9    -0.9      4.6     2.0      2.7     4.2      4.3      6.4       3.3     5.7
 Exports (goods & services)                      2.2      2.2    -2.3     -2.1    -1.9     -0.9     5.1      5.8      0.0       2.0    10.1
 Imports (goods & services)                      4.7      2.8    -1.1     -0.6    -2.9     -2.1     3.3      6.0      1.4       1.0    11.1
Contributions to GDP (% points)
 Domestic final sales                            5.0      1.8     0.1      2.4     2.5      2.4     1.6      2.5     2.3        2.2     3.1
 Inventories                                     0.6      1.2     3.2      4.0    -1.4     -2.1    -4.2     -1.3     2.3       -2.3     0.8
 Net trade (goods & services)                   -4.0     -0.5    -3.0     -3.7     1.4      2.0     4.9      1.5    -2.8        2.5     1.3
Unemployment rate (sa, %)                        2.1      2.0     1.9      2.1     2.2      2.2     2.1      2.1     2.0        2.2     2.4
Consumer prices                                  4.9      5.3     4.2      5.0     4.4      4.0     3.8      3.4     4.8        3.9     3.6
Exports                                          6.0     -0.5    -5.8     -3.0     0.1      3.5     8.8      8.2    -1.2        5.3    12.1
Imports                                         11.7      2.6    -3.1     -4.3     0.1      2.3     7.0      8.3     1.5        4.3    13.1
Merchandise trade balance (US$bn)                7.2      6.7     8.8     11.6     7.1      8.1    11.2     12.3    33.4       38.7    40.3
Current account balance (% of GDP)              15.9     15.9    17.2     14.0    12.8     12.7    19.3     19.4    15.7       16.1    17.0
Fiscal Balance (% of GDP)                                                                                            0.2       -0.2     0.4
3 month SIBOR (%)                               0.38     0.38    0.38     0.38    0.38     0.48    0.48     0.48    0.38       0.48    0.50
Exchange rate (SGD/USD)                         1.26     1.27    1.23     1.22    1.21     1.20    1.20     1.19    1.22       1.19    1.17
Notes: Numbers in bold are actual values; others forecast. Interest rate and currency forecasts are end of period; other measures are
period average. All forecasts are modal forecasts (i.e., the single most likely outcome). Table reflects data available as of 28 November
2012. Source: CEIC and Nomura Global Economics.

Nomura | Asia Special Report                                                                                              28 November 2012

South Korea: Growth to rebound from a very low base

We expect the Bank of Korea to keep rates unchanged at 2.75% through 2013 as                                   Young Sun Kwon
                                                                                                               +852 2252 1370
GDP growth and CPI inflation should rise modestly from a very low base.                              

Activity: September industrial output and October export numbers suggest that GDP may have
bottomed out in Q3. We expect GDP growth to rebound to 0.5% q-o-q in Q4 (from 0.2% in Q3)
and to a sequential quarterly average of 0.8% in 2013, supported by inventory restocking in Q4
and a modest foreign demand recovery in 2013. But compared to past recoveries, this one is
tepid despite starting from a very low base. An important reason is weak domestic demand, held
back by structural problems, including a household sector overburdened in debt equivalent to
156% of personal disposable income. So we maintain our below-consensus forecast of 2.5%
GDP growth in 2013 – far below our potential GDP estimate of 3.5%, which we expect to be
reached only in 2014. The new government will likely increase social welfare spending, but this
will only partly offset the export slump, given the headwinds on personal consumption from high
household debt and falling house prices. We expect business investment to remain weak as
uncertainty surrounding the global outlook and new government reforms remain elevated.

Inflation: A negative output gap and stable KRW should exert downward pressure on inflation,
but higher food prices and fading favourable base effects (from a one-off decline in school fees
and expenses) should push CPI inflation up to 2.7% in 2013 from 2.2% in 2012, although still
below the midpoint of the BOK‟s new inflation target range of 2.5-3.5% for 2013-15.

Policy: We expect the BOK to keep rates at 2.75% through 2013, as growth should increase
slightly and CPI inflation should rise modestly, each from a very low base on a sequential basis.

Risks: As a small, open, financially integrated economy, Korea is vulnerable to sudden
changes in global economic conditions, commodity prices and financial markets. That said, we
would expect the BOK to cut rates if one of the major downside risks to global growth (the US
fiscal cliff; a renewed eurozone sovereign crisis; a China hard landing) actually materialises, but
none of these are held in Nomura Global Economics‟ base case. Domestically, the new
government could formulate a supplementary budget in H1 2013, which provides an upside risk
to our domestic demand forecast.

Details of the forecast
% y-o-y growth unless otherwise stated              1Q12 2Q12         3Q12    4Q12    1Q13    2Q13    3Q13    4Q13    2012    2013    2014
Real GDP (sa, % q-o-q, annualised)                    3.5  1.1          0.6     2.0     2.8     3.6     3.2     3.6
Real GDP (sa, % q-o-q)                                0.9  0.3          0.2     0.5     0.7     0.9     0.8     0.9
Real GDP                                              2.8  2.3          1.6     1.8     1.6     2.3     2.9     3.3     2.3     2.5    3.5
 Private consumption                                  1.6  1.1          1.5     2.5     2.0     2.2     2.0     2.1     1.9     2.1    2.3
 Government consumption                               4.4  3.6          3.3     5.1     2.7     4.0     4.1     4.1     3.9     3.7    4.1
 Business investment                                  9.1 -3.5         -6.0    -0.9    -9.2    -1.5     5.1     5.1    -0.2    -0.4    7.7
 Construction investment                              2.1 -2.1         -0.1    -0.6     1.6     3.0     3.9     4.1    -1.2     3.1    4.1
 Exports (goods & services)                           5.0  3.2          2.6     6.6     2.9     4.1     2.5     2.5     3.9     3.0    4.8
 Imports (goods & services)                           4.6  0.5          0.9     5.6     0.7     3.2     2.5     2.5     3.0     2.2    5.2
Contributions to GDP growth (% points)
 Domestic final sales                                  2.8    0.8       0.7     1.2     0.8     1.8     2.1     3.1     1.5     1.8     3.0
 Inventories                                          -0.1    0.1      -0.1    -0.4    -0.4    -0.3     0.5     0.0     0.1     0.2     0.2
 Net trade (goods & services)                          0.1    1.4       1.0     1.2     1.2     0.8     0.2     0.3     0.7     0.6     0.3
Unemployment rate (sa, %)                              3.4    3.3       3.1     3.2     3.2     3.2     3.2     3.2     3.3     3.2     3.2
Consumer prices                                        3.0    2.4       1.6     1.8     2.1     2.8     3.1     2.8     2.2     2.7     3.0
Current account balance (% of GDP)                                                                                      3.3     2.3     2.0
Fiscal balance (% of GDP)                                                                                               1.3     1.0     1.0
Fiscal balance ex-social security (% of GDP)                                                                           -1.2    -1.3    -1.0
BOK official base rate (%)                            3.25    3.25     3.00    2.75    2.75    2.75    2.75    2.75    2.75    2.75    3.25
3-year T-bond yield (%)                               3.55    3.30     2.83    2.80    2.80    2.90    3.00    3.00    2.80    3.00    3.30
5-year T-bond yield (%)                               3.69    3.42     2.93    2.90    2.90    3.00    3.05    3.10    2.90    3.10    3.50
Exchange rate (KRW/USD)                              1133    1154     1118    1080    1065    1060    1055    1050    1080    1050    1040
Notes: Numbers in bold are actual values; others forecast. Interest rate and currency forecasts are end of period; other measures are
period average. All forecasts are modal forecasts (i.e., the single most likely outcome). Table reflects data as of 28 November 2012.
Source: Bank of Korea, CEIC and Nomura Global Economics.

Nomura | Asia Special Report                                                                                                 28 November 2012

Taiwan: External demand holds the key

The economy should benefit from an upcycle in China's GDP and global electronic                                Young Sun Kwon
                                                                                                               +852 2536 7430
demand, along with an improved cross-strait relationship.                                            

                                                                                                               Aman Mohunta
Activity and inflation: Exports declined slightly in October, by 1.9% y-o-y, following a 10.4%                 +91 22 6617 5595
increase in September. We expect GDP growth to recover more visibly in Q4, but from a low            

base. Stronger demand from China and a gradual recovery in global demand for electronics
should help lift Taiwan‟s GDP growth from 1.0% in 2012 to 3.0% in 2013 and further to 3.5% in
2014, as strengthening economic linkages with China start to increasingly benefit (see below).
We expect CPI inflation to rise to 2.3% in 2013 from 2.0% in 2012 due to higher food prices and
consumption. Given that electricity tariff hikes will be implemented in multiple stages, inflation is
unlikely to become a serious negative factor for growth through our forecast horizon.

Cross-strait relationship: We expect economic linkages between Taiwan and China to
continue to strengthen, through further trade liberalisation under the Economic Cooperation
Framework Agreement and an increase in tourist arrivals from China. Taiwan‟s central bank and
China‟s PBoC signed a Currency Settlement MOU in August, which should significantly boost
RMB-related business in Taiwan‟s capital markets. Improving cross-strait ties is a structural
transformation that, over time, should unleash major benefits for Taiwan‟s economy through
higher value-added trade and investment with China, and deepening capital markets.

Monetary policy: We expect the Central Bank of China (CBC) to hike discount rates from
1.875% to 2.125% in H2 2013 as GDP growth and CPI inflation should rise. We view this as
more a normalisation of very loose monetary policy, rather than a move to outright tightening.

Risks: Another deep recession in advanced economies would have a large impact on Taiwan‟s
open economy. Positive risks include a stronger-than-expected recovery in the global
electronics cycle and a faster-than-expected liberalisation of trade and investment with China.

Details of the forecast
% y-o-y growth unless otherwise stated             1Q12    2Q12     3Q12      4Q12    1Q13    2Q13    3Q13    4Q13    2012     2013    2014
Real GDP (sa, % q-o-q, annualised)                   5.6    -0.4      3.9       1.6     7.3     0.3     5.6    -4.1
Real GDP                                             0.6    -0.1      1.0       2.7     3.1     3.2     3.6     2.2    1.0      3.0     3.5
 Private consumption                                 1.9     1.6      0.9       1.0     1.9     2.6     2.8     2.8    1.3      2.5     3.2
 Government consumption                              2.1     2.5     -0.7       1.5     3.0     3.5     3.0     2.6    1.3      3.0     3.4
 Gross fixed capital formation                     -10.2    -7.7     -0.5       0.0     7.0     5.0     4.0     4.5   -4.6      5.1     4.5
 Exports (goods & services)                         -3.4    -2.5      1.8       2.5     2.8     3.4     4.0     2.2   -0.4      3.1     3.3
 Imports (goods & services)                         -7.2    -4.1      1.2       3.0     2.2     2.2     2.0     2.4   -1.8      2.2     3.5
Contributions to GDP growth (% points)
 Domestic final sales                               -2.4    -1.1        0.0     2.5     3.8     3.2     4.4     1.9    0.6      4.1     3.2
 Inventories                                         1.5     0.5        0.5     0.1    -0.4     0.0    -0.4     0.1    0.2     -0.5     0.2
 Net trade (goods & services)                        1.7     0.5        0.6     0.3     0.8     1.3     1.9     0.3    0.7      1.1     0.5
Exports                                             -4.0    -0.5        4.3     5.0     5.3     5.9     6.5     4.7   -1.7      5.6     6.3
Imports                                             -5.9     0.3        5.7     7.2     3.7     3.7     3.5     3.9   -2.1      3.7     5.0
Merchandise trade balance (US$bn)                    5.7     5.6        8.4     7.8     7.0     7.4    10.9     8.8   27.4     34.2    40.0
Current account balance (% of GDP)                   9.6     9.6        9.7     7.6     6.9     7.4     9.5     7.8    9.1      7.9     7.4
Fiscal balance (% of GDP)                                                                                             -1.8     -1.9    -2.0
Consumer prices                                      1.3     1.6      2.9       2.1     2.1     2.2     2.5     2.2    2.0      2.3     2.3
Unemployment rate (%)                                4.1     4.2      4.3       4.3     4.3     4.2     4.2     4.2    4.3      4.2     4.2
Discount rate (%)                                   1.88    1.88     1.88      1.88    1.88    1.88    2.00    2.13   1.88     2.13    2.13
Overnight call rate (%)                             0.42    0.51     0.38      0.51    0.51    0.64    0.41    0.51   0.51     0.76    0.76
10-year T-bond (%)                                  1.27    1.23     1.19      1.29    1.29    1.29    1.42    1.55   1.29     1.55    1.55
Exchange rate (NTD/USD)                             29.5    29.8     29.3      29.0    28.9    28.7    28.7    28.7   29.0     28.7    28.2

Notes: Numbers in bold are actual values; others forecast. Interest rate and currency forecasts are end of period; other measures are
period average. All forecasts are modal forecasts (i.e., the single most likely outcome). Table reflects data available as of 28 November
2012. Source: CEIC and Nomura Global Economics.

Nomura | Asia Special Report                                                                                               28 November 2012

Thailand: New growth engines

Investment and consumption spending will provide a boost to GDP growth even as the                           Euben Paracuelles
                                                                                                             +65 6433 6956
external outlook remains uncertain, spurred by loose monetary and fiscal policies.                 

                                                                                                             Nuchjarin Panarode,
Activity: We forecast 2013 GDP growth at a solid 4.5% after recovering sharply to 5.5% in                    CNS Thailand
2012 after last year‟s floods. We believe domestic demand, supported by accommodative                        +662 638 5791
monetary and fiscal policies, will mitigate the impact of weak exports. Private consumption
should receive a boost from the sharp rise in real wages (the minimum wage was hiked by 40%
this year, putting upward pressure on overall wages as well), while private investment should be
bolstered by higher public infrastructure spending, the industrial sector upgrading production
capacity after the floods, and a relatively more stable political outlook (see Asia Special Report:
Thailand: New growth engines, 24 September 2012). These will be the new growth engines that
help drive and rebalance the Thai economy, making it more resilient to external shocks.

Monetary policy and inflation: We expect inflation to remain stable at 3.0% in 2013, as the
government utilizes subsidies to contain emerging price pressures. As a result, we expect the
Bank of Thailand (BOT) to keep the policy rate unchanged at 2.75% throughout 2013, following
a cumulative 75bp of cuts since the floods. This implies negative real policy rates, and hence
even with the BOT on hold, the monetary policy stance should remain accommodative for some
time. There is room to cut further if the external outlook deteriorates sharply, or if domestic
demand fails to strengthen fast enough to offset the export weakness.

Fiscal policy: The budget deficit is set at 2.4% of GDP in FY13, from an estimated 2.0% of
GDP in FY12. Public debt to GDP has risen steadily since early 2012, from 40.6% to 43.9% in
September. This is still well below the debt ceiling of 60%, so there is plenty of scope to run
expansionary fiscal policies. Including non-budgetary spending – such as that on water-
management infrastructure and the planned THB2.27bn of mega-project investment – we
forecast a “cash” deficit in FY13 of 3.5% of GDP versus 2.5% estimated in FY12.

Risks: The downside risks to our forecasts stem from a deepening of the euro area recession,
and domestically, from increased political uncertainty over the constitutional amendment and
reconciliation bill. Slow progress on infrastructure plans could weaken investment sentiment.

Details of the forecast
% y-o-y growth unless otherwise stated          1Q12    2Q12     3Q12    4Q12     1Q13    2Q13    3Q13     4Q13     2012      2013    2014
Real GDP (sa, % q-o-q, annualised)               53.3    11.7      5.0    -2.2      1.8    12.4     7.7     -1.7
Real GDP                                          0.4     4.4      3.0    15.2      4.0     4.1     4.8      4.9     5.5       4.5     5.0
 Private consumption                              2.9     5.3      6.0     8.2      6.8     6.6     4.0      2.8     5.6       5.0     4.2
 Public consumption                              -0.2     7.6      9.0    -1.1      0.8    -3.6    -5.8      7.2     4.1      -1.0    -0.8
 Gross fixed capital formation                    5.2    10.2     15.5    15.6     10.0     5.9     4.6      7.9    11.5       7.0    10.1
 Exports (goods & services)                      -3.2     1.1     -2.8    17.4      4.9     2.6     5.0      3.9     2.6       4.1     5.0
 Imports (goods & services)                       4.3     8.6     -1.8     8.6      3.6     1.1     4.9      2.7     4.7       3.1     5.0
Contribution to GDP growth (% points)
 Domestic final sales                             2.5     5.9      7.6     7.6      5.6     4.6     2.5      3.7     5.8       4.1      4.5
 Inventories                                      2.9     2.8     -3.8     0.7     -1.5    -2.1     0.4      1.2     0.7      -0.5     -0.1
 Net trade (goods & services)                    -4.7    -4.2     -1.1     7.2      1.5     1.2     0.7      1.3    -0.9       1.2      0.7
Exports                                          -1.4     0.0     -3.8    14.8      4.9     4.2     7.7     -0.9     2.3       5.0      6.9
Imports                                          10.4    11.9     -1.7     8.8      3.2     4.4    13.0      5.9     6.5       6.6      7.2
Merchandise trade balance (US$bn)                -5.2    -5.2     -1.6    -3.9     -4.4    -5.5    -5.0     -5.8   -15.9     -20.6    -22.9
Current account balance (US$bn)                   1.4    -2.4      2.7     0.6      0.6    -2.3    -0.3     -0.6     2.4      -2.6     -2.8
Current account balance (% of GDP)                1.6    -2.7      3.1     0.7      0.6    -2.3    -0.3     -0.6     0.7      -0.7     -0.7
Fiscal balance (% of GDP, fiscal year basis)                                                                        -2.5      -3.5     -3.7
Consumer prices                                   3.4     2.5     2.9      3.4     3.1      2.9     2.7      2.9     3.0       3.0      3.1
Unemployment rate (sa, %)                         0.7     0.9     0.6      0.6     0.9      0.8     0.6      0.6     0.7       0.7      0.7
Overnight repo rate (%)                          3.00    3.00    3.00     2.75    2.75     2.75    2.75     2.75    2.75      2.75     3.25
Exchange rate (THB/USD)                          30.8    31.8    30.8     30.5    30.3     30.1    30.0     29.9    30.5      29.9     29.2
Notes: Numbers in bold are actual values; others forecast. Interest rate and currency forecasts are end of period; other measures are
period average. All forecasts are modal forecasts (i.e., the single most likely outcome). Table reflects data available as of 28 November
2012. Source: CEIC and Nomura Global Economics.

Nomura | Asia Special Report                                                                                       28 November 2012

FX outlook: a story of two halves

We maintain our broadly long Asia FX portfolio into 2013 and are likely to add or roll the majority    Craig Chan
of our current positions through the first half of next year. As discussed in the opening letter by    +65 64336106
our Chief Asia Economist Rob Subbaraman, Nomura Economics‟ view of reduced concerns
over the US fiscal cliff, stronger China growth, capital inflows to Asia and rising inflation should   Wee Choon Teo
                                                                                                       +65 6433 6107
support our trading bias for 2013. But given risks mainly from uncertainties in the global   
backdrop (namely from the eurozone and the US), we recommend being long currencies that
are supported by structural flows and have relatively strong current account surpluses (see            Prateek Gupta
                                                                                                       +65 6433 6197
Figure 31 for our forecasts).                                                                

Fig. 31: Asia FX forecast                                                                              Prashant Pande
                                                                                                       +65 6433 6198
                27-Nov-12      End-2012    1Q13       2Q13           3Q13      End-2013    End-2014
 CNY               6.29          6.26      6.22       6.18           6.16        6.15        6.14
         Fwd                        6.27      6.24       6.30           6.31        6.33        6.44
 HKD               7.75          7.75      7.75       7.75           7.75        7.75        7.75
         Fwd                        7.75      7.75       7.75           7.75        7.75        7.75
 INR               55.6          54.0      54.5       56.0           60.0        59.0        56.0
         Fwd                        55.9      56.8       57.5           58.3        59.0        61.5
 IDR               9639          9620      9660       9680           9730        9800        9600
         Fwd                       9632      9728        9844          9964       10094       10700
 MYR               3.04          3.02      2.97       2.95           2.93        2.92        2.84
         Fwd                        3.05      3.06       3.08           3.09        3.10        3.15
 PHP               40.8          40.6      40.2       39.8           39.6        39.2        38.2
         Fwd                        40.8      40.8       40.8           40.8        40.8        41.4
 SGD               1.22          1.22      1.21       1.20           1.20        1.19        1.17
         Fwd                        1.22      1.22       1.22           1.22        1.22        1.22
 KRW               1084          1080      1065       1060           1055        1050        1040
         Fwd                       1086      1091        1095          1099        1101        1110
 TWD               29.1          29.0      28.9       28.7           28.7        28.7        28.2
         Fwd                        29.0      28.9       28.8           28.7        28.6        28.3
 THB               30.7          30.5      30.3       30.1           30.0        29.9        29.2
         Fwd                        30.8      30.9       31.0           31.2        31.3        31.9

Source: Bloomberg, Nomura.

First half – appreciation
Specifically, KRW and MYR are seeing strong inflows into local bond markets from central
banks/sovereign wealth funds (CB/SWFs), while PHP continues to be supported by the strength
of overseas worker remittances. Asia FX, especially KRW, will benefit if our view of a pickup in
net capital inflows in 2013 materialises. We are also optimistic on CNY appreciation into H1
2013 given signs of stabilising capital flows, our forecast of strong China economic recovery
(against a pessimistic consensus) and rising local inflation.

Capital inflows are likely to keep USD/INR stable (at best) in H1, as investors lose patience with
the government‟s efforts to address the fiscal deficit. Indeed, once we exit our remaining long
INR position (positioned through options and held since 3 September) we are likely to begin
trading INR with a short bias. SGD should benefit from sovereign flows and any pick up in
capital inflows, but given rich FX valuations (the trade-weighted basket is close to the topside of
the policy band), remaining short S$NEER makes sense from a risk-reward basis as well as a
hedge to our portfolio. For TWD, we recommend being long USD/TWD as another hedge given
the risk of the US fiscal cliff, the appreciation priced into the NDF curve and the risk of
macroprudential controls.

Nomura | Asia Special Report                                                                                         28 November 2012

Second half – differentiation
Going into H2, we expect more differentiation in Asia FX. Higher inflation and overheating risks
should support FX appreciation in most of Asia, as well as present risks to countries and
currencies such as INR and IDR. But the performance of Asia FX may be weighed down by still
relatively weak, though bottoming out, developed economy growth2 (H2 2013 GDP at 1.5%
against 0.5% y-o-y in H1) and our China Chief Economist Zhiwei Zhang‟s view of slower growth
in China (7.0% in Q4 versus 8.4% in Q1 2013; see China outlook for more details). In addition,
our G10 FX Strategy team forecasts USD/JPY at 88 by end-2013, which could raise concerns
about the performance of Asia FX.

In H2, the outperformers are likely to be PHP and MYR, in our view. Aside from some resilience
to global/regional headwinds, structural factors and current account surpluses, higher inflation
and rate hikes in the Philippines and Malaysia could further support their currencies. KRW, CNY
and SGD (if the S$NEER is not at the extreme strong side of the policy band) are likely to be
mid-performers. KRW could face increased FX intervention risk as South Korea‟s current
account surplus shrinks, whilst SGD performance could be weighed down by the relatively weak
global backdrop and JPY weakness. For China, despite higher inflation, a narrowing current
account surplus and the economic slowdown in H2 could raise medium-term structural concerns.
These are likely to limit CNY appreciation.

Underperformers are likely to be TWD, which will face the brunt of slower China growth, the still
relatively weak global growth backdrop and a weak JPY. INR and IDR are likely to face
depreciation risk as inflation can be expected to have a negative effect on both currencies,
particularly as India and Indonesia both run current account deficits. INR could depreciate (vs.
USD) towards a record high of around the 60-figure level, especially if there is no fiscal resolve,
which we judge will be difficult ahead of the 2014 elections. IDR will also face depreciation
pressure from capital outflows (primarily bond related) if the government is unable to stem
inflation pressures and a less conducive political environment3 ahead of elections in 2014. This
is also likely to lead to a slowdown in FDI inflows.

We do not expect the USD/HKD peg to change in 2013, but we expect strong capital inflows to
lead to the strong side of the Hong Kong Monetary Authority‟s 7.750 convertibility undertaking to
be frequently tested. Economic and social pressure for a shift in FX regime would need to
escalate for any near-term change, but we believe this is unlikely given Nomura‟s view of steady
growth and limited headline inflation. As for USD/THB, we expect it to be a mid-performer in
2013 with appreciation driven by robust domestic economy, and strong capital flows attributable
to public and private investments4.

Seven trade recommendations
     1)    Short USD/PHP (fix 16 January 2013, $15mn, entry on 16 October, 7 November
           and 27 November 2012, targeting 40.50 spot – last around 40.95)5

We will remain short USD/PHP through 2013 given our spot USD/PHP forecast of 39.8 by
mid-2013 and 39.2 by year-end.

We have been increasing our short USD/PHP position (initial position USD5mn, fixing on 16
January 2013) with our optimism in the near-term partly coming from the remittance season in
December. Our analysis shows that over the past 10 years, the average spot USD/PHP rate in
the first two weeks of December has been on average 90bp lower than in the last half of
November. However, beyond the short-term seasonal support, we remain positive PHP given
solid structural inflows (from remittances and business process outsourcing; Figure 32), strong
macroeconomic fundamentals (our economist, Euben Paracuelles, expects 50bp of rate hikes
from Q3 2013; see the Philippine outlook) and a favourable political backdrop that should
sustain strong reform momentum. These developments could lead to sovereign rating upgrades
in H2 2013 (see the Credit outlook section).

  US, Japan, and the Euro area; See Global FX in 2013, 25 November 2012, for our broad view on opportunities in EM
outperformance and differentiation trades.
  See Asia Special Report: Indonesia - Policy swings, 2 August 2012
  See Asia Special Report: Thailand: New growth engines, 24 September 2012
  See Asia Insights: PHP: Adding to our short USD/PHP position, 7 November 2012

Nomura | Asia Special Report                                                                                       28 November 2012

Fig. 32: Rising inflows from business process outsourcing and overseas worker

       USD mn                         BoP: Current Account
    2,000                             BoP: Business Process Outsourcing
                                      BoP: Overseas Worker Remittance





     Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12

Source: CEIC, Nomura.
The main risk to being long PHP is macroprudential controls. However, these may target local
asset markets (real estate) as well as measures to allow for greater outflows via the
liberalisation of FX regulations. Other risks include a pickup in FX intervention as well as
possible earlier external debt repayments, but we believe all of these are still only likely to be a
temporary offset against the structural and non-cyclical strength of the current account surplus
(primarily from overseas worker remittances).

Fig. 33: Financing gap analysis – PHP is relatively less vulnerable

(USD bn)                                                KRW CNY          TWD     THB PHP IDR       INR     M YR
Current Account (Economist forecast 2013)                28.0  93.4       40.5    -2.6  5.6 -18.4 -72.0     15.8
Net FDI                                                 -16.7 142.5       -8.7    -1.9  0.6 10.2 14.5       -3.4
Net Equity Flows                                        -16.8 -42.7      -11.6    -5.4 -3.3 -6.6 -18.6      -7.2
Net Bond Flows                                          -15.3  -2.7       -1.5    -2.0 -4.4 -2.3   -0.7    -23.9
- Deposit shift out of local FX                           0.1   0.0        0.1     0.3  0.0   0.2   0.1      0.3
- ST External Debt Maturing                              39.8 176.5       32.3    17.7  2.1 11.5 27.8       10.4
- Coupon Payment on LT External Debt                     11.8   7.5        0.4     2.7  3.9 11.6 21.4        2.0
Financing Gap                                           -72.5   6.6      -14.1   -32.6 -7.5 -40.4 -126.0   -31.4
FX Reserves (Latest available as of 21 Nov 12)          323.5 3285.1     399.2   181.4 81.7 110.3 260.5    138.3
Financing Gap / FX reserves                             -22%    0%        -4%    -18% -9% -37% -48%        -23%
FX Fwd (Latest available as of 21 Nov 12)                26.3  n.a.       n.a.    24.8  3.4  -0.2 -14.1      7.9
Financing Gap / (FX reseves + FX Fwd)                   -21%   n.a.       n.a.   -16% -9% -37% -51%        -21%

Notes: Current account is Nomura Economics‟ 2013 forecast; Net FDI is the last four quarters, with a
15% fall assumed (assume 50% of the avg 30% experienced during the US financial crisis; negative
net FDI becomes less negative while positive net FDI becomes less positive); a 1.5% fall in the latest
total foreign equity holdings as % of market cap (50% of the avg 3% fall in FEH/Mkt cap during the
US financial crisis); 50% of the fall in FBH/Outstanding during the US financial crisis for KR, ID, IN
and MY; 50% of the avg fall in FBH for KR, ID, IN, MY applied on IIP debt positions for CN, TW, TH,
PH; a 10% of max deposit shift from Jun 1997 to Dec 1998; 70% of ST external debt is rolled; and
coupon payments on long-term external debt are estimated using a weighted average fixed coupons.
Source: CEIC, Bloomberg, Nomura.

        2)   Short USD/CNY (fix 31 December 2012, $30mn, entry on 14 September and 7
             November 2012, targeting 6.26 by year-end – fix last at 6.2902)6

Our bias in H1 is to remain short USD/CNY targeting 6.18 on the fix by mid-2013. H2 will
be more tactical despite our forecast of 6.15 given the less favourable local growth cycle.

Our outlook for a pick-up in domestic growth indicators and rising inflation implies more
supportive cyclical drivers for CNY appreciation in H1. Indeed, for the first half of the year, our
regression analysis indicates that the forecast pick-up in growth and inflation should lead to
more CNY appreciation7 (Figures 34 and 35). Additional positive CNY news into H1 is that there
have been more indications of stabilising capital flows in China (Figure 36). As confidence in
China‟s economic cycle builds, we expect net capital inflows to strengthen. This view is also
supported by the smooth passing of the US presidential elections (with President Obama‟s re-

    See China primed to surprise on the upside, 14 September 2012
    See Asia Insights: Asia FX portfolio update – Short TWD and long PHP, 27 November 2012.

Nomura | Asia Special Report                                                                                                        28 November 2012

election seen as the more CNY-friendly result) and the transition to China‟s next generation of
political leaders. Given that there has been limited CNY appreciation this year (17bp on the fix
from 30 December 2011 to 28 November), there is scope for an acceleration in CNY strength
(against USD) in December to keep political pressures suppressed.8 Specifically, we note that in
the last 10 trading sessions of the year in 2006, 2007, 2010 and 2011, USD/CNY fell by an
average 49bp9.

Fig. 34: China: inflation and CNY appreciation                                           Fig. 35: China: industrial production and CNY appreciation

                  China Inflation % y/y             USDCNY (inverted)                                       China IP % y/y    USDCNY (inverted)
10                                                                            6.0         23%                                                          6.0
                                                                              6.5         19%                                                          6.5
    4                                                                         7.0                                                                      7.0
    2                                                                                     13%
                                                                              7.5                                                                      7.5
                                                                              8.0          9%                                                          8.0
    -4                                                       8.5                           5%                                                       8.5
     Jul-05 Jul-06 Jul-07 Jul-08 Jul-09 Jul-10 Jul-11 Jul-12                                Jul-05 Jul-06 Jul-07 Jul-08 Jul-09 Jul-10 Jul-11 Jul-12

Source: Bloomberg, Nomura.                                                               Source: Bloomberg, Nomura.

Fig. 36: Financial institutions net FX purchase position

100                       Position for Forex purchase (m-o-m change, USD bn)







      Jan-07 Aug-07 Mar-08 Oct-08 May-09 Dec-09 Jul-10 Feb-11 Sep-11 Apr-12

Source: CEIC, Nomura.

Beyond the short-term CNY-positive factors, CNY appreciation may slow in H2 as China‟s
growth slowdown weighs against the relatively high inflation backdrop. The risk from slower
growth is that investors increase their focus on medium-term concerns such as an over-reliance
on investment, high debt levels, nonperforming loans and the vulnerability of the property
market. In addition, JPY weakness may also weigh marginally against lower USD/CNY fixes.

          3)   Short USD/MYR (fix 20 December 2012 and 7 January 2013, $15mn, entry on 11
               September and 7 November 2012, targeting 3.02 by year-end – spot last around

Our conviction to be short USD/MYR remains strong. We will continue to build long MYR
positions into Q3 given our USD/MYR forecasts of 2.95 by mid- and 2.92 by end-2013.

  Indeed, the US Treasury report on FX policy released on 27 November refrained from labelling China a currency
manipulator but said that CNY remains “significantly undervalued” and that there has been an “insufficient degree of
  Amount of CNY appreciation vs. USD (fix basis) in the last 10 trading sessions of the years: 2006 at -0.13%, 2007 at -
0.74%, 2010 at -0.55%, 2011 at -0.54%.
   See Asia FX: A post-election portfolio update, 7 November 2012.

Nomura | Asia Special Report                                                                                                     28 November 2012

The market is relatively pessimistic on MYR, mainly because of local factors, but we expect this
to fade given limited negative implications from the fall in palm oil prices, the Employment
Provident Fund‟s (EPF) dollar purchase-related outflows and the upcoming general election.
Externally, China‟s improving near-term economic outlook and the continued global policy
stimulus are likely to be supportive of MYR in H1.

On palm oil prices, Nomura‟s Malaysia equity research team expects a price rebound in the
coming months, while our analysis highlights the minimal impact on trade and equity related
flows11 relative to total exports (with palm oil exports at USD18bn against total exports of
USD228bn over the past 12 months) and the basic balance (USD15.2bn over the past 12-
months). On EPF-related outflows, our estimates are of a monthly average of USD0.7bn12 of
foreign currency purchases in the rest of the year, which is a significant slowdown from the
market estimate of USD5bn transacted in June and July 2012 (see Figure 38). On the general
elections13, which are likely to be held during the school holidays in 23-31 March 2013, we
continue to expect a reasonable outcome, with Barisan Nasional to retain a reduced majority of
around 130 seats (from 137).

Fig. 37: USD/MYR and palm oil prices m-o-m changes                             Fig. 38: EPF asset allocation and overseas investment flow

                  Palm oil price (m-o-m change)                                 EPF asset allocation and overseas investm ent flow
     40%                                                       -8%
                  USDMYR (m-o-m change, RHS, inverted)                                                 Q2-12   Q1-12    2011     2010
     30%                                                       -6%              Loans and bonds (%)       33      32      33       32
     20%                                                       -4%
                                                                                MGS (%)                        27         27      28      27
     10%                                                       -2%              Equities (%)                   34         33      34      35
      0%                                                       0%               Money market (%)                 3          5       3       5
                                                                                Property (%)                     3          3       3       0
     -10%                                                      2%               AUM (MYR bn)                 494.8      488.3   468.9   445.9
     -20%                                                      4%
                                                                                Overseas holdings           15.5%       14.0%   13.4%    9.8%
     -30%                                                      6%
     -40%    Palm oil exports: 7.9% of total exports           8%               investm ent during                2.9     1.2     5.5      3.3
             Allied product: 3.3% of total exports                              period (USD bn)
     -50%                                                      10%
        Jan-11 May-11 Sep-11 Jan-12 May-12 Sep-12
                                                                               Source: EPF, Nomura.
Source: CEIC, Bloomberg, Nomura.

Strong growth in H1 (Euben Paracuelles forecasts GDP growth of 4.7%; see Malaysia Outlook),
a solid current account surplus of 4.9% of GDP, or USD8.0bn, in H1; CB/SWF bond-related
inflows; and the market likely to begin pricing a tightening of monetary policy from Q3 should all
continue to support MYR. The risk to MYR remaining a strong performer in H2 is a slowdown in
growth, partly because of China, but also on the government‟s fiscal consolidation drive.

       4)   Short USD/KRW through a seagull (1080/1100/1175, fix 23 January 2013, $20mn,
            entry 23 October 2012, premium 37bp)14 and short 3M USD/KRW through cash
            (fix 22 February 2013, $5mn, entry on 22 November 2012, targeting 1065 by Q1)15

Despite FX intervention, we believe a break of 1080 is likely in the near term, with the
next key level at 1060. 2H could see slower appreciation with our end-2013 USD/KRW
forecast at 1050.

Korea‟s FX intervention on 22 November and the 27 November announcement that it will
reduce the ceiling on bank's FX derivative positions, may slow, but not change, KRW‟s trend
appreciation path, in our opinion16. This is because the main sources of inflows are SWF/CB
purchases of local debt and the strong current account surplus – flows that are considered as
less volatile. In addition, we believe the statement made by Deputy Finance Minister Choi on 22

   See MYR: Impact of the palm oil price slide, 5 October 2012.
   Estimated from end-June balance sheet and assuming H2 AUM increase the same amount as H1, a planned overseas
holdings target of 19% and USD2.5bn of transactions in July.
   See Asia Insights: The Malaysian general election revisited, 8 November 2012.
   See Asia FX portfolio update: enter short USD/KRW through options, 23 October 2012.
   See Asia FX portfolio update – Long KRW and short S$NEER, 22 November 2012.
   See South Korea: ceiling on bank FX derivative contracts lowered, 27 November 2012.

Nomura | Asia Special Report                                                                                                          28 November 2012

November that the country is "more concerned with the pace of won gains than the level”
supports our outlook.

Into 2013, we expect there to be a few themes leading to further KRW appreciation, including
the political desire to implement an “Economic Democracy” This should continue to create some
market speculation of KRW appreciation (even after the presidential election on 19 December)
despite our Korea economist Young Sun Kwon‟s view that addressing income inequality will be
pursued more by fiscal policy than FX policy17. The second theme is likely to be signs of the
economy strengthening (recently in exports, industrial production and a lower inventory-
shipment ratio). The third is capital inflows from CB/SWF inflows (Figure 39) and the current
account surplus (Figure 40).

Fig. 39: Foreign CB/SWF net investment in Korean bonds                                    Fig. 40: Korea – balance of payments

                   Foreign investments in Korean bond (USD bn, lhs)
                   by CBs/SWFs
                   by Private Sector
                   CBs/SWFs holding (% of Total Foreign Holding, rhs)
 20                                                                          40%             4%
 15                                                                          30%
                  6.4%                                                                       0%
               17.0 3.3 13.7     15.6 7.6 7.9            6.5 12.1            0%             -2%
                                                                    -5.5     -10%                                           CA (12m rolling, % of GDP)
     -5                                                                                     -4%
                                                                             -20%                                           PI (12m rolling, % of GDP)
                                                                                                                     FDI (12m rolling, % of GDP)
-10                                                                          -30%           -6%
                  2009                2010                   2011                             Jan-07 Nov-07 Sep-08 Jul-09 May-10 Mar-11 Jan-12

Source: FSS, Nomura.                                                                      Source: CEIC, Nomura.

If there is a pickup in net foreign equity inflows as Nomura Asia Economics expects, this
could be a strong source of support for KRW appreciation. That said, we do not view this as a
necessity as seen over the past two months. Despite USD1.5bn of net foreign equity
outflows18, KRW has appreciated by around 2.3% against USD (on a spot basis) because of
current account and bond inflows. But a pickup in foreign equity inflows could be a double-
edged sword as the risk is that FX intervention as well as macroprudential controls may rise –
especially in H2 with our view of a narrower current account surplus (2.5% of GDP for Q4
2013 from 3.1% for Q4 2012).

          5)   Short USD/INR through a USD put / INR call spread (55.25/54.0, fix 20-Dec, NDF
               ref 56.51, $10mn, 69.3bp, entry 3 September 2012, premium 63bp)19

We look to fade any rally in INR. Spot may stay around a 54-56 range into H1 2013, but
without fiscal reform, we would begin to trade USD/INR from the long side given the risk
of new record highs in 2013.

As we highlighted in our September report on India‟s balance of payments20, we expected INR
to rally all the way towards year-end because of the temporary narrowing of the current account
deficit, potential global policy stimulus and authorities enacting more aggressive policies to
attract capital inflows. Beyond the long INR recommendation through options, we had
established a tactical short USD/INR cash position. However, we believe that the time to fade
our tactically optimistic view on INR is fast approaching, with an opportunity possibly at the
winter parliament session, which started on 22 November and runs until 20 December. The
winter session may see a number of important bills on the table (Figure 41), including the

   See South Korea: An Economic Democracy, 14 November 2012.
   From October start till 22 November.
   See Asia Special Report: India's chronic balance of payments, 3 September 2012.
   See Asia FX Insights: INR – The next few positive events to watch, 25 September 2012. We booked profits on short.
USD/INR cash position on 8 October (See First Insights: INR: Take profit on short USD/INR cash position, 8 October 2012).

Nomura | Asia Special Report                                                                                                                   28 November 2012

Insurance Laws Bill (increasing the foreign ownership cap to 49% from 26%), the Land
Acquisition Bill and the Direct Taxes Code Bill21.

Fig. 41: Indian reforms announced so far

                    Reform m easures announced so far                                                 Im pact                                  Fully Im pem ented
                                                           Do not require parliam entary approval
Fuel price hike (diesel by INR5/litre and capping of subsidised LPG cylinder)  Reduce fiscal defict by 0.1pp                                            √
FDI liberalization in multi brand retail (51% FI limit), aviation (49%), in          Boost stable capital inflow s. Improve supply chain and
broadcasting (74%) and pow er exchanges (49%)                                        logistics to low er food inflation in the medium term

Disinvestment of government stakes in four public sector units (MMTC,
                                                                                     Bridge the fiscal gap                                              X
Withholding tax on long-term infrastructure bonds and external commercial
                                                                                     Low er cost of capital for infrastructure projects                 √
borrow ings cut to 5% from 20%
Launch Rajiv Gandhi Equity Savings Scheme                                      Increase household savings in equity markets                             X
Restructuring pow er discom liabilities (financial package for state           Improve the financial viability and reduce losses in the
governments/discoms w hich includes compulsory annual tariff hike)             pow er sector
Resolving fuel-supply issues for pow er producers                              Improve revenues                                                         √
Kelkar Committee Report (tax measures, increase disinvestments, cut            Fiscal consolidation over the medium term (if
subsidies, right-size plan expenditure)                                        implemented)
Insurance sector (review the 75% stipulation in AAA instruments, expand        Boost the insurance base and expand investable
SPV criteria to non-PSUs, reduce bureaucratic processes)                       insurance products
                                                                               Reduce leakages and increase the effectiveness of
Linking of all school grants to Unique Identification (UID)                                                                                             X
                                                                               cash transfers
                                                                               Accelerate flow of long-term debt for infrastructure
Cleared a tripartite agreement for setting up of Infrastructure Debt Fund                                                                               X
                                                                               projects once the fund is established
                                                                               To encourage retailers and prevent black marketeering
Urea price increased by INR50/tonne (1%)                                       and use of subsidised urea fertilizers for industrial                    √
                                                               Require parliam entary approval

Increase FDI limit in the insurance sector and allow foreign reinsurers' entry       Increase capital in the insurance sector                           X

FDI in the pension sector and make Pension Fund Regulatory and
                                                                                     Develop the pension sector                                         X
Development Authority (PFRDA) a statutory body
                                                                                     Corporate governance and corporate social
Companies Bill                                                                                                                                          X

Competition Amendment Bill                                                           Extension of the Competition Commission‟s jurisdiction             X

Approved Forw ard Contract Regulation Act (Amendment) Bill or FCR(A) Bill            Give more teeth to the Forw ard Market Commission                  X

Source: PIB, Nomura Global Economics.

Fig. 42: India’s balance of payments breakdown

 USD bn                                            2011             2012         2013
 Current Account                                     -63              -77          -72
 Merchandise                                       -168             -194         -204
   Exports                                         306.8            302.1        360.8
   Imports                                         475.3            496.2         565
 Invisibles                                        105.7            116.1        131.1
 Capital Account                                   60.3             79.2         67.7
   o/w Foreign Direct Investment                   21.8             16.5         17.2
   o/w Portfolio Investments                         3.4            26.1         16.5
   o/w Commercial borrowings                          11              9.4           12
 Overall Balance                                    -5.1              1.8         -4.7
 Current account (% of GDP)                         -3.4             -4.2         -3.8
Source: CEIC, Nomura Global Economics.

Although INR could see some support into 2013 from our economists‟ view of capital inflows
into Asia, we believe the negative local fundamentals in India – the lack of fiscal consolidation,
the long road ahead in terms of implementing reforms 22, high and sticky inflation and the large

  See Asia Insights: India: A heated winter session of parliament, 20 November 2012.
  Land Acquisition Rehabilitation and Resettlement (LARR) Bill, Direct electronic cash transfers through a Unique
Identification (UID) scheme, National Investment Board, and Introduction of a goods & services tax – see Asia Special
Report: India reforms (Part I): A long way to go, 25 October 2012.

Nomura | Asia Special Report                                                                                                                     28 November 2012

current account deficit (Figure 42) – are likely to limit any INR performance against USD in H1.
Indeed, unless there are solid steps taken by the government to tackle the fiscal deficit and
improve the investment climate, to which we are skeptical given it is a pre-election year, our
bias in 2013 (particularly in H2) will be to build on a long USD/INR position.

           6)    Short SGD vs basket23 ($40mn total notional; US$10mn, fix 11 December 2012,
                 entry 11 September 2012; $20mn, fix 14 January 2013, entry 12 October 2012;
                 US$10mn, fix 22 February 2013, entry 22 November 2012)24

One of the main hedges to our Asia FX portfolio that we will continue to use is S$NEER –
especially if it remains near the extreme strong side of the policy band.

The main reason for us to build on a short SGD against a basket recommendation is because of
rich FX valuations, the positive carry (3M at +130bp, 28 November), and a hedge for our Asia
FX portfolio. With S$NEER only 30bp from the top of the band and 370bp from the bottom, risk-
reward continues to be in favour of being short S$NEER (Figure 43). Into H2 2013, the weaker
JPY and still relatively soft global growth will weigh on SGD. That said, the probability of a policy
shift towards easing in 2013 remains low as inflation remains relatively high (Figure 44) and
capital inflows may lead to further asset price inflation.

Fig. 43: Nomura’s S$NEER model                                                                                     Fig. 44: Headline and core inflation

                Jan-1999 = 100                                                                                     10%
     122                          Apr-11: Recentred                                                                           Headline inflation (y-o-y, %)
                                  midpoint higher but below
     120                          prevailing S$NEER
                                                                                                                    8%        MAS Core inflation (y-o-y, %)
     118              S$NEERmod
                      S$NEERmid                                                                                     6%
     114              S$NEERlow
     112                                                                                    Oct-12: Maintain the
                                                                                            policy of a modest
                                                              Oct-11: Reduced
                                                                                            and gradual             2%
     108                                                      the slope of policy
     106                                                                                                            0%
                                                                                Apr-12: Increased
     104                                                                        slope slightly and
                                       Oct-10: Increased
                Apr-10: Appreciation
                                       appreciation slightly and
                                                                                restored a narrower                -2%   YTD Headline: 4.7% y-o-y
     102        bias and recentred                                              band
                S$NEER higher
                                       widened policy band slightly                                                      YTD Core: 2.7% y-o-y
     100                                                                                                           -4%
       Jul-09 Nov-09 Mar-10 Jul-10 Nov-10 Mar-11 Jul-11 Nov-11 Mar-12 Jul-12 Nov-12
                                                                                                                     Jan-06   Oct-07    Jul-09     Apr-11

Source: Bloomberg, Nomura.                                                                                         Source: CEIC, Nomura.

           7)    Long 3M USD/TWD ($5mn, fix 25 February 2013, entry on 27 November 2012,
                 entry level 28.87, annualised carry: 2.8%)

This is another hedge to our portfolio into 2013. Ahead, we will position tactically on
USD/TWD through the year with a general bias to be long USD. We forecast USD/TWD at
28.7 by end-H1 and 28.65 by end 2013.

We are short TWD as an additional hedge given the risk of the US fiscal cliff, recent TWD
strength (against USD), the appreciation priced into the NDF curve (3M NDF 2.8% annualised
appreciation and at -2.3 standard deviations; Figure 45) and risk of macroprudential controls. If
a resolution to the US fiscal cliff emerges before end-2012, we will unwind this hedge. However,
if the fiscal cliff is unresolved towards year-end, this trade is likely to perform as the seasonal
year-end remittance from insurance corporations may weaken. TWD is also likely to see
negative forces from the slowdown in China in H2, still relatively weak global demand and a
weaker JPY (Figure 46).

   Short S$NEER basket details: Long USD/SGD (100% of notional), short USD/MYR (15%), short USD/CNY (13%), short
USD/JPY (11%), long EUR/USD (11%), short USD/IDR (8%), short USD/KRW (5%), short USD/TWD (4%), short USD/THB
(2%), short USD/INR (2%), short USD/PHP (2%), long AUD/USD (3%) and long GBP/USD (3%)
   See Asia FX Insights: Singapore: Economic, FX and rates views after MAS leaves policy unchanged, 12 October 2012.

Nomura | Asia Special Report                                                                                                             28 November 2012

Fig. 45: Compressed NDF curves provide opportunities to                             Fig. 46: TWD – Vulnerable to China slowdown and JPY
hold long USD/TWD positions                                                         weakness

Avg Rtn of a HTM strategy w hen 3M points are depressed

              If 3M pt     If 3M pt     If 3M pt     If 3M pt                                                                         BIS NEER
                                                                                                           Exports (12m rolling)
              low er than low er than low er than low er than                                                                         Weights
1Y Sample     1 SD         0 SD         -1.5 SD      -2 SD                                              (% of total        (as % of
Total                  239           98           26           14                                        exports)            GDP)
Count +ve Rtn           95           45           14            9                                 US       11%                7%        13%
Count -ve Rtn          141           52           12            5                                 EU       6%                 4%        11%
Hit                39.7%        45.9%        53.8%        64.3%                                   China    27%               17%        27%
Avg +ve Rtn          2.0%         2.7%         4.0%         3.5%                                  Japan    6%                 4%        19%
Avg -ve Rtn        -1.6%        -1.1%        -1.0%        -0.8%
Avg Rtn             -0.2%         0.7%         1.7%         2.0%

Source: Bloomberg, Nomura.                                                          Source: BIS, CEIC, Nomura.

Six themes driving Asia FX in 2013
The view from Nomura Economics into 2013 suggests a bullish backdrop for Asia FX at least in
the first half of the year. These include the belief that a global economic heart attack like 2008-
09 is unlikely, despite slow global growth, and other positive factors including fading concerns
over the US fiscal cliff, continued loose global monetary policies, a China rebound, rising
inflation and robust capital inflows leading to the risk of overheating. Beyond these, we identify
some specific drivers of Asian currencies:

1. Structural inflows into Korea, Singapore and Malaysia bonds
After the US financial crisis and the emergence of the eurozone crisis in 2010, asset allocation
by central banks and sovereign wealth funds (CBs/SWFs) into Korea, Singapore and Malaysia
picked up substantially. There are some significant benefits from these flows for Asian
currencies, including reduced vulnerability of local markets to global financial pressures, but
also authorities in the region have, and are likely to be less reactive against such inflows. Korea
is where the data are more readily available, showing CBs/SWFs accounted for 6.4%
(USD2.8bn) of total foreign ownership in 2009 before increasing rapidly to 30.1%
(USD21.8bn)25 by 2011. For 2012, the Korea Financial Supervisory Service (FSS) has not
published data, but there has been much anecdotal evidence from official sectors (Norges Bank
Investment Management and Swiss National Bank, for e.g.) that CB/SWF net investment is
likely to have remained strong. The FSS in its 2012 monthly releases noted that net investment
has been “mainly” from foreign central banks. In particular, from January to October 2012, the
two largest net buyers have been Norway, with net investment of USD3.0bn, followed by
Switzerland with USD2.2bn (Figure 47). Furthermore, Korea‟s rating upgrade26 is likely to have
improved perceptions of Korea as a safe destination for bond flows. Indeed, the FSS has said
that the rating upgrade has been a factor contributing to strong net bond investment of
USD1.3bn in September.

   We have made the conservative assumption that foreign government institutions held zero Korean bonds prior to 2009 in
estimating the percentage of total foreign holdings.
   Moody‟s upgraded Korea from A1 to Aa3 on 27 August, Fitch from A+ to AA- on 6 September and S&P from A to A+ on
14 September 2012.

Nomura | Asia Special Report                                                                                                                   28 November 2012

Fig. 47: Holdings of Korean bonds                                                      Fig. 48: Current account trends in Asia

                               Korean bond holdings in USD bn                           10                   Current Account as % of GDP
         ∆YTD :
         $1.1bn              Mar-11      Jun-11      Sep-11      Dec-11
                             Mar-12      Jun-12      Sep-12      Oct-12                  8

     8                           YTD (avg increase per country):
                                 USD1.7bn                                                6
                          ∆YTD :
                          $2.2bn                                ∆YTD :                   4
     4                                      ∆YTD :              $3.0bn
                                                                                                          All Asia             Ex CN, ID, IN

     0                                                                                   0
           China         Switzerland      Kazhakstan          Norway                     Dec07 Jul08 Feb09 Sep09 Apr10 Nov10 Jun11 Jan12

Source: FSS Korea, Nomura.                                                             Source: CEIC, Nomura.

2. Current account surpluses are still relatively strong in some countries
Current account surpluses in the region have fallen since the US financial crisis (to 2% of GDP
as of Q2 2012, on a 12-month rolling average), but mainly because of the fall in China‟s surplus
and sizable deficits in India and Indonesia. However, excluding these three countries (because
of China‟s weight in Asia, India and Indonesia because we are medium-term bearish and prefer
to short these currencies), current account surpluses in the rest of Asia, while smaller than four
years ago, remain quite large, at 5.7% of GDP in Q2 2012 (Figure 48), and not too far from pre-
crisis levels (6.7% of GDP in Q2 2008). Malaysia‟s current account surplus has fallen to 6.4% of
GDP in Q3 (from 16.5% in Q2 2008), while South Korea‟s has continued to rise since the end of
2011, to around 3.6% of GDP in September (1.7% in Q2 2008). Note that the actual USD flow
remains large at USD19.1bn for Malaysia over the past 12-months and USD40.0bn for Korea in
the same period.

3. Deleveraging may continue, but is likely to be gradual
The data on outstanding eurozone bank loans to Asia is encouraging in that there has already
been rapid deleveraging. From Q2 2011 to Q2 2012, outstanding eurozone bank loans to Asia
fell 21% (or USD85bn), to USD329bn, with the sharpest falls in Q3 2011 and Q4 2011 (an
average 10.2% q-o-q fall).

Indeed, the breakdown provides further good news as the main source of deleveraging is the
French banks27 (Figure 49). French bank lending to Asia fell by 39% (-USD64bn) from Q2 2011
to Q2 2012 and was led by a reduction in loans to South Korea which fell 39%, or by USD15bn
from Q2 2011 to Q2 2012.

Although the improvement in credit conditions in Q1 2012 (after the ECB‟s 3yr LTRO) and in Q3
(after the ECB announcement of OMTs in September) may have led to a stabilisation in
eurozone bank lending to Asia, but the risk of further deleveraging remains intact as European
and US banks have yet to reach minimum capital standards to meet Basel III core Tier 1 ratios28.
That said, the pace of deleveraging is likely to be gradual, which will be key for Asia FX.

  40% of total eurozone lending to Asia in Q2 2011, falling to 31% in Q2 2012.
  Fully phased Basel III core Tier 1 ratios for the largest global banks at end-2011 stood at 8.9% in Europe, versus 8.3% in
the US and 9.0% in Asia. European regulators on average ask their banks for higher minimal capital standards, averaging
10% in this sample, compared with around 9% in both the US and Asia (see UK and European Banks presentation, 15
June 2012). The ratio for EU banks has since improved to 9.5% as of Q3 2012. Our European bank analysts expect most
EU banks to be Basel 3 compliant by 2013 (see European Banks: Update, 16 November 2012).

Nomura | Asia Special Report                                                                                                         28 November 2012

Fig. 49: Eurozone banks claims on Asia                                                 Fig. 50: FX valuations

                                                                                                                         Raw Model Output
                                                                                                                        FEER SEER     Avg
                                                                                                     India               15    20      18
                                                                                                     Thailand             1      5      3
                                                                                                     Indonesia            -2   11       5
                                                                                                     Korea                -5    -8     -6
                                                                                                     Hong Kong            -3    -7     -5
                                                                                                     Philippines         -12    -5     -8
                                                                                                     China                -8    -6     -7
                                                                                                     Malaysia             -4   -18    -11
                                                                                                     Singapore           -24   -18    -21
                                                                                                     Taiwan              -34   -16    -25

                                                                                       Note: Valuations based on data up to Q2 2012.
                                                                                       Source: Bloomberg, CEIC, Nomura.
Source: BIS, Nomura.

4. Broadly favourable FX valuations
Despite currency appreciation this year, FX valuations in Asia remain broadly favourable, with
an average undervaluation of around 5.8% based of our FEER (current account-based) and
SEER (stock flow-based) models. Excluding IDR and INR, which are 4.5% and 17.6%
overvalued (the two currencies we are biased to be short in 2013), Asia‟s average FX
undervaluation deepens to around 10%. Our views to be long PHP, MYR, KRW and CNY are
supported by our FEER and SEER models (Figure 50). While TWD remains the most
undervalued currency in Asia at 25.1%, we believe its performance will be limited by
intervention/macroprudential control risks and the appreciation priced into the NDF forward

5. FX intervention and/or macroprudential controls
The risk of FX intervention and/or macroprudential controls will continue to rise, the most recent
evidence coming from Korea, where on 22 November, authorities intervened heavily on
USD/KRW29 and announced that further restrictions on banks‟ FX derivative positions were an
option. The authorities have since cut the ceiling on FX derivative contracts held by local banks
from 40% of capital to 20% and for foreign bank branches, from 200% to 150%, effective 1
January 2013. However, as highlighted by Deputy Finance Minister Choi30, this was to address
more the pace of KRW appreciation rather than the actual level of USD/KRW. In our view, aside
from KRW remaining competitive, the authorities are likely to allow for gradual FX appreciation
in the coming months partly because the structure of inflows since October has been primarily
current account- and CB/SWF-related, but also because of recent large current account
surpluses. Furthermore, the semi-annual US Treasury report on FX policies released on 27
November has continued to press the Korean authorities to limit their FX interventions to
exceptional circumstances.

However, the risk ahead is that as capital inflows into Asia pickup in 2013, the overarching risk
for Asia, as highlighted by our economists, is overheating and rising inflation later in 2013. This
suggests increased Asia FX appreciation pressure and increased risk of FX intervention
(Figures 51 and 52) and macroprudential controls in the region. That said, we still expect
authorities to lean on, rather than stem, FX appreciation, while macroprudential controls are
likely to target the source of capital inflows that is most viewed as volatile or speculative.

     Reuters article “S.Korean authorities buy close to $1bln in intervention to curb won‟s rise, ” 22 November 2012.
     Bloomberg “S.Korea more concerned with pace of won gains than level,” Deputy FM Choi Jong Ku, 22 November 2012.

Nomura | Asia Special Report                                                                                                              28 November 2012

Fig. 51: Adjusted Asian FX reserve growth                                                     Fig. 52: Estimated intervention

Adjusted Asian FX reserves growth                                                             Estimated Intervention - Adjusted Asian FX reserves
(m-o-m change, USD bn)                                                                        growth + FX Forwards (m-o-m change, USD bn)
               INR     IDR    KRW     MYR      PHP     SGD     TWD     THB       CNY          Date         INR    IDR    KRW    MYR      PHP     SGD     THB
     Aug-11    0.7      2.0    1.4     0.9      4.1     0.2    -0.2     0.8      19.5          Aug-11       0.7    2.0   -0.2    0.7      1.0     3.1     1.4
     Sep-11    2.7     -8.3   -2.5    -2.6     -0.2   -10.5    -3.0    -5.2      11.7          Sep-11       2.7   -9.1   -7.4   -5.0     -3.6   -11.7    -4.9
     Oct-11    1.6     -1.4    4.5     2.5      0.4     9.4     0.2     0.6      36.3           Oct-11      1.6   -1.9   -4.3   -3.0     -1.3     7.4     2.2
     Nov-11    3.0     -2.0    0.2     1.1      0.6    -2.4    -2.1    -2.6     -22.9          Nov-11       1.4   -2.5   -2.8    1.4      0.6    -4.6    -0.8
     Dec-11    4.8     -0.4    0.7     0.1     -0.6    -1.0     1.3    -1.9      -5.7          Dec-11       5.1   -0.7    1.1   -0.8     -1.2    -2.7    -1.5
     Jan-12    6.4      1.5    3.8    -0.1      1.9     6.8     3.3     2.8      59.5           Jan-12      6.5    1.8    0.7    0.2      2.7     4.3     2.4
     Feb-12    2.1      0.1    3.9     0.4     -0.3     1.1     3.4     2.1      48.1           Feb-12      2.0    0.7    3.9    1.1     -0.5     1.4     0.6
     Mar-12    0.5     -1.6    0.3     1.0     -0.8    -3.3    -0.3    -0.9      -3.1           Mar-12     -1.2   -1.6   -1.3    2.8     -1.1    -2.9    -0.9
     Apr-12    0.2      5.7    0.6     0.1      0.3     2.3     0.9    -0.8       3.9           Apr-12      0.0    6.6   -1.2    0.0      0.4     1.9     0.3
     May-12    0.3     -3.1   -0.1     2.5      0.0    -3.8     1.5    -4.8      -1.3          May-12      -6.6   -3.5   -1.3    2.2     -0.1    -6.0    -4.2
     Jun-12    1.9     -5.6   -0.5    -2.5     -0.1     4.2    -0.5     2.3      11.1           Jun-12     -1.9   -5.4   -1.0   -4.2      0.3     0.3     2.0
      Jul-12   2.4      0.6    4.0     1.1      3.8     2.3     2.4     1.3      23.9            Jul-12     2.0    1.0    4.0    0.7      0.9     1.9     0.5
     Aug-12    0.4      1.8    0.5    -0.4      0.8     0.4     0.6     3.0       9.5          Aug-12       0.8    1.6   -0.2   -0.5     -0.1    -0.5     0.2
     Sep-12    1.2      0.5    2.8     1.6      0.9     4.2     0.9     3.3     -13.6          Sep-12       1.3    0.6    2.4    2.7      0.5     0.8     1.0
     Oct-12    0.7      0.1    1.2     0.8     -0.3     1.9     1.0    -2.1

12m avg        2.0     -0.2    1.5     0.5     0.5     1.1      1.0     0.1     12.1          12m avg      0.9    -0.3   0.0    0.2       0.1      0.1   0.2
3m avg         0.8      0.8    1.5     0.6     0.5     2.2      0.8     1.4      6.6          3m avg       1.4     1.0   2.1    1.0       0.4      0.7   0.6

Source: CEIC, Bloomberg, Nomura.                                                              Source: CEIC, Bloomberg, Nomura, IMF.

6. JPY depreciation
JPY depreciation (vs. USD) to 88 by end-2013 as forecast by Nomura‟s G10 FX Strategy team
may raise some concerns over the potential negative impact on Asia FX. However, our analysis
of single variable sensitivity analysis, multivariate analysis (Figure 53) and trade-basket
weightings suggests that the impact will be limited.31 Combine this with the competitiveness
some Asia economies (namely Korea and Taiwan; Figure 54) have gained over the past 10
years along with the broad undervaluation of Asia FX, and there is less reason to be concerned
about the implications for local FX policy.

In addition, given the positive risk environment and strong capital inflows into Asia in H1 2013,
JPY depreciation will become even less of an issue for Asia FX, in our view. However, into H2,
persistent JPY depreciation could become a more significant factor given the expected
slowdown in China, a still-soft global growth backdrop and a possible slowdown in capital

Fig. 53: HFP test results                                                           Fig. 54: Asia exports (rolling 12m)

 Currency            Dollar    Euro          Yen       R-Sq
                                                                                                          Exp -Japan                   Exp-Korea
CNY                  93%         6%          1%        98%                              400
                                                                                                          Exp-Taiwan                   Exp - Asia ex China
HKD                  98%         2%          0%       100%                              350
IDR                  73%        32%          -5%       58%
INR                  73%        35%          -8%       66%
KRW                  65%        60%          -34%      46%                              250
MYR                  71%        31%          -8%       76%                              200
PHP                  81%        28%          -8%       74%
SGD                  60%        35%          0%        83%                              150

THB                  76%        26%          0%        69%                              100
TWD                  73%        25%          -2%       87%
Average              76%        28%          -6%       76%                               Oct-02 Mar-04 Aug-05 Jan-07 Jun-08 Nov-09 Apr-11

Source: Bloomberg, Nomura.                                                          Source: CEIC, Bloomberg, Nomura.

     See Asia Insights: Impact of a weaker JPY on Asia FX, 21 November 2012.

Nomura | Asia Special Report                                                                                           28 November 2012

Rates outlook: Global factors to dominate early,
local drivers emerge in H2

Nomura‟s view of the global economic outlook for 2013 is that it remains weak, with global                Kewei Yang
                                                                                                          +65 6433 6246
growth of 3.0% in 2013, unchanged from this year and below the trend rate, even though central  
banks will try to offset weak growth by adopting yet more unorthodox monetary policies. The
                                                                                                          Advin Pagtakhan
main reasons for the weakness include deleveraging/deeper financial sector regulation, the                +65 6433 6555
ongoing eurozone crisis and pro-cyclical fiscal austerity in developed countries. However,      

outperformance by emerging markets, especially Brazil and China, is expected to partially offset          Vivek Rajpal
the negative contributions to growth from developed markets (DM).                                         +91 22 403 74438
Given such a backdrop, we still expect global risk sentiment to be a dominant factor driving
global asset performance. Capital inflows, attracted to Asia by a brighter growth outlook and
higher interest rates, should help local-currency fixed income assets outperform DM
benchmarks from a total return perspective (due to spread compression over USD rates,
currency appreciation and reduced credit premium). We expect a range-bound market to
experience a number of major phases in 2013 as DM dynamics continue to weigh on risk

          Phase 1: Once a solution to the US fiscal cliff is found, it is likely that risky assets will
          perform while the rates market sells off, early in the year. Furthermore, we expect
          growth in China in Q1 2013 to exceed 8% y-o-y, and in the US, the Fed to replace
          Operation Twist with the outright buying of about USD40bn of USTs a month.

          Phase 2: The risky asset rally might not last long as US macroeconomic data are not
          expected to improve much in Q1 2013, while the eurozone may be led into a deeper-
          than-expected recession by fiscal tightening, financial deleveraging and sovereign debt
          market tensions. Our European economics team expects another bout of market
          turbulence once Spain is forced to seek a bailout, and even when the ECB‟s open
          market transaction (OMT) mechanism is triggered, we believe it will be quickly seen by
          market participants as underwhelming.

          Phase 3: In H2 2013, we expect US economic growth to accelerate as emerging
          markets continue to grow, which might put pressure on some Asian central banks to
          tighten policy to reduce the risk of economic overheating. Our US rates strategy team
          expects the 10yr UST yield to reach 2.2% by end-2013 while our Asian economics
          team forecasts rate hikes in China, Taiwan, Indonesia, Malaysia and the Philippines in
          H2. Our US rates and Asian economic outlook for H2 suggest that paying interest may
          emerge in Asia as most rates curves in the region have only priced in a marginal rise in
          yields. We believe Taiwan will be the best market to position for this view due to its
          fairly close relationship with USD rates and as its economy is expected to benefit more
          from China‟s above-trend growth in H1 2013. Even though the Bank of Korea is not
          expected to hike rates in 2013, we believe Korean rates will exhibit movements similar
          to Taiwan rates.

Even though we expect a range-bound market with upward pressure on rates in the year ahead,
we are positioning ourselves in Asian rates markets cautiously at the beginning of 2013, while
closely monitoring global risk sentiment (related to the US economic recovery and Euro debt
crisis) and regional growth drivers (such as China). We also remain mindful of idiosyncratic
dynamics in various countries, especially India, where rates markets are less correlated with the
rest of the world.

Our portfolio is currently positioned as follows:

China and Taiwan: We have a paying and steepening bias as we expect above-trend growth in
China. For Taiwan, the regional and domestic recovery, and rising USD rates, should put bear
steepening pressure on the curve.

Singapore: We stay received front-end rates as a balanced way to express our bullish view on
the local economy and concerns over global risk sentiment.

Nomura | Asia Special Report                                                                             28 November 2012

Korea: We maintain a tactical paying bias to position for shifts in global risk sentiment given the
Korean market‟s relative depth and low transaction costs.

India: We continue to hold a receive bias on OIS and a bullish stance on government bonds as
we expect the RBI to continue to ease and inject liquidity into the system through OMOs.

In other cash bond space (mainly Korea, Malaysia and Thailand): capital inflows caused by
QE in developed markets, a better EM outlook and higher EM yields should help bonds
outperform swaps locally and US Treasuries internationally (on a relative basis).

Lastly, to diversify risk and add less-correlated returns to our Asian rates portfolio, we also
intend to explore occasional relative value opportunities in markets closely linked with the US,
such as Hong Kong (HKD peg to USD) and Singapore (SGD NEER policy regime and the swap
offer rate (SOR) fix mechanism), followed by small open economies like Taiwan.

Key recommendations for 2013: SGD, INR and CNY rates
We start by highlighting our high conviction trade recommendations for the year ahead. We then
provide our thoughts on individual country markets.

         Singapore: remain received where there is attractive volatility-adjusted slide.

         India: bullish on bonds and maintain a received bias on the 3-5yr part of the curve.

         China: position for further bear steepening.

         We would position for our medium-term outlook into H2 2013 by paying Taiwan and
          Korea 5yr (in spot and/or the forward space) and manage short-term risk through
          tactically hedging with USD rates.

Singapore: receive where there is favourable volatility-adjusted slide
         Receive 3fwd 1yr and 4fwd 1yr IRS which are carry trades with high rolldown-to-
          volatility ratios.

         Receive the back end of the SGD IRS curve (5fwd 5yr) against a regression-weighted
          amount (0.50) of USD 5fwd 5yr.

In Singapore, closer to the front end of the SGD IRS curve, we maintain our recommendations
to receive SGD 3fwd 1yr and SGD 4fwd 1yr, given the supportive MAS policy stance and what
we see as good risk-reward properties (see Asia Insights: Singapore: remain received SGD
IRS, 6 November 2012). The SGD 3fwd 1yr and SGD 4fwd 1yr currently slide positively by 17bp
and 21bp over 6M, respectively (Figure 55) and remain favourable to receive when we adjust
this forward rate slide by both realised and implied volatility. In addition, given the curve‟s strong
relationship with the USD curve and the Fed‟s extended low-rates guidance, this should also
serve to dampen volatility in the SGD curve and improve the overall ex-ante Sharpe ratio. For
those interested in spot tenors, when we adjust the carry/roll by realised volatility, we see that
SGD 7yr and 6yr IRS have the best risk-reward characteristics in this space. Both our current
recommendations and these spot alternatives should also benefit from the rolling flattening of
the IRS curve in an environment of stable and low SOR fixes (Figure 56).

In terms of the fundamental backdrop, we believe high headline inflation relative to its long-term
historical average is supportive of our view of no loosening in the MAS policy stance (even amid
below-trend growth), as it is this measure that feeds into consumers‟ inflation expectations. In
terms of policy tools, the targeted annualised appreciation slope for the S$NEER is of most
interest to rates investors. A positive slope (hawkish stance) for the S$NEER path puts
downward pressure on the 6M SOR fix, as the SOR fix is a function 6M USD Sibor (USD Libor
fixed in Singapore) less the amount of annualised SGD appreciation reflected in the USD/SGD
6M FX forwards.

At the back end of the curve, we maintain our rolled down recommendations to receive SGD
5fwd 5yr against USD 5fwd 5yr and look to add should valuations become favourable.
Currently, the regression-weighted spread between SGD 5fwd 5yr to 0.50 * USD 5fwd 5yr
(existing recommendation uses a weight of 0.4) slides positively by 7bp over 6M, compared to
the negative slide on an equally weighted spread. Alternative combinations involving SGD vs.
USD 3fwd 3yr and USD 3fwd 2yr are also robust and carry positively if beta-adjusted, though

Nomura | Asia Special Report                                                                                                    28 November 2012

we eschew allocating fresh risk capital to them because on a relative value basis we see these
pairs at fair value.

We believe that below-trend growth, global risks, regulatory-driven demand and, to some extent,
the rolling flattening dynamic in the IRS curve should keep yields in this part of the SGD rates
curve low. As Singapore moves towards updating its risked-based capital framework for
insurers, this should result in regulatory-driven demand. We believe implementation of the
proposed changes – which is a similar concept to the Solvency II framework in Europe –
provides an incentive for insurers to increase their government bond holdings given higher
charges for holding equities and corporate bonds. This additional demand for sovereign
duration is also likely to result in receiving interest in the back end of the IRS curve, as some
insurers look to synthetically recreate duration exposure. In terms of where we may see the
manifestation of this synthetic demand, this may well occur in the 20yr part of the IRS curve
(liquidity permitting).

Fig. 55: SGD 4fwd 1yr, slide and SOR fix                                  Fig. 56: SGD IRS curve over the past 6M, %

 5%                                                            125               2.0
                         4fwd 1yr - annual slide (bp, RHS)
                         Swap offer rate 6M - %
 4%                      SGD IRS 4fwd 1yr - %                  100                                                                          1.73
                                                                                 1.5                                                      1.61
 3%                                                            75                                                               1.29

 2%                                                            50                1.0
                                                                                                             0.76 0.91
 1%                                                            25                                     0.64
                                                                                 0.5 0.56 0.54 0.56
 0%                                                            0

-1%                                                            -25               0.0
      08          09           10      11        12                                    1yr 2yr 3yr 4yr 5yr 6yr 7yr 8yr 9yr 10yr

Source: Bloomberg, Nomura.                                                Source: Bloomberg, Nomura.
We are comfortable that we will be able to maintain these views over the medium term, given
the stated policy and economic backdrop, and as the substantial positive slide also augments
the holding power of the trade. That said, the main risk comes from the global backdrop. Any
sharp deterioration in the global growth outlook could see the market price in a more dovish
MAS, which would result in a rise in the SGD 6M SOR fix pushing up the front end of the curve.
As we move into H2 2013, the potential for stronger sequential growth in advanced economies
could weigh on our directional recommendation to receive SGD 5fwd 5yr, given the robust
relationship with the USD rates curve, though the relative value trade should be more insulated
and provide more alpha.

India: stay bullish going into 2013
          Long bonds. We recommend IGB 8.07% 2017 (5yr) (Current 8.17%; Target 7.7%;
           Reassess 8.37%), IGB 8.15% 2022 (10yr) (Current 8.19%) and IGB 8.33% 2026 (14yr)
           (Current 8.31%). These are the three most liquid on-the-run government bonds. We
           expect the 10yr and 14yr to outperform on the curve on open market operations
           (OMOs), which we expect to resume soon. We would expect the 5yr to outperform
           once the RBI begins to cuts rates, which we believe will start in January.

          Receive 3-5yr (ND) OIS. We recommend scaling into receive belly trades at or above
           7.30% levels.

          (ND) OIS 3s7s, 3s10s, 1fwd 2s5s steepener. We recommend entering into steepeners
           once rate cuts arrive, and/or when liquidity conditions ease. Tactical: Pay 1yr or 1s5s
           flattener. Earn the carry in the front end while the RBI is on hold and there is a liquidity
           deficit. Look to exit ahead of the first rate cut.

Our view on Indian rates has been bullish since the end of 2011 and we see few reasons to
change our minds as we enter 2013. Below we discuss the reasons for our bullishness and our
key recommendations.

Nomura | Asia Special Report                                                                                             28 November 2012

RBI to continue to 'ease' further

Despite the RBI's hawkish rhetoric (which we believe receives undue attention or emphasis) a
closer look at the RBI‟s actions suggests that it has been easing monetary conditions since the
beginning of 2012. Not only has the repo rate been reduced by 50bp, but approximately
INR1.1trn has been injected into the system via a cumulative 175bp of cuts in the cash reserve
requirement ratio (CRR) and approximately INR1.7trn through OMOs since the start of the
calendar year. Not only that, but other RBI measures such as cutting the statutory liquidity ratio
(SLR) and the export credit refinance facility have made banking system access of liquidity
easier. By conducting these various liquidity measures, the RBI has eased money market
conditions significantly this year, which has led to 100bp fall in average MIBOR fixings.

As we head into 2013, we expect this easing of monetary conditions to continue. Our
economics team, Sonal Varma and Aman Mohunta, expects 50bp of repo rate cuts in H1 and
another 25bp of cuts to the CRR (see India outlook), while we expect OMOs to continue. We
note that this easing is consistent with our economists' view of inflation peaking in Q4 12 and
shifting to a downtrend thereafter.

Sovereign bonds to rally further as demand continues to outweigh supply

Indian sovereign bonds have rallied since the end of 2011 as demand, especially from the
banking system, and the RBI in the form of it OMOs, continues to outweigh supply, which is
being spurred on by the government‟s poor fiscal position. We believe this demand is due to two
factors (which we have written about before32) that are our key reasons to be bullish Indian
sovereign bonds:

                Banking system demand remains strong in a low credit growth environment. Despite
                 the mandatory 23% SLR requirement, banks continue to hold nearly 30% of their
                 NDTL33 in their portfolio (Figure 57).

                The RBI's willingness to inject liquidity in the form of OMOs. We expect the RBI's
                 efforts on this front to only increase over time as it becomes more overt in supporting
                 growth, with inflation peaking. We would not be surprised if the RBI becomes even
                 more proactive and brings liquidity in the banking system to neutral levels, which will
                 be consistent with its stance of keeping liquidity at +/-1% of NDTL.

We believe both these factors will continue in 2013 and hence, expect yields to find new lows. We
expect the 10yr to reach 7.8% in Q1 2013 before consolidating in Q2 (which is typically a high
issuance quarter), before starting a gradual downward trajectory again to end 2014 at 7.5%.

In terms of the yield curve, we expect a limited steepening on our expectation of only 50bp of
repo rate cuts while OMOs should keep the longer end rich.

Fig. 57: SLR, Non-food credit, y-o-y                                                    Fig. 58: MIBOR, policy rates

35%                            SLR/NDTL (LHS)                             30%           10%
                               Non Food Credit y-o-y (RHS)                               9%
                                                                          25%            8%
31%                                                                                      7%
                                                                          20%            6%
29%                                                                                                                    MIBOR O/N
                                                                                                                       Repo rate
                                                                          15%            4%
27%                                                                                                                    Reverse Repo
                                                                                         3%                            1M AVG OF MIBOR
25%                                                                       10%            2%
            10                11                 12                  13                       10                11      12
Source: Bloomberg, Nomura.                                                              Source: Bloomberg, Nomura.

     India Rates: Time to initiate longs, 22 August 2012.
     NDTL = Net Demand and Time Liabilities (~ aggregate deposits of banking system).

Nomura | Asia Special Report                                                                           28 November 2012

(ND) OIS. Keep the receive bias in the belly (3-5yr tenors) and look to shift to steepeners
once rate cuts arrive and/or liquidity eases further

The (ND) OIS34 curve has been pricing in 100bp of MIBOR fixing change in 1 year. As we have
written before,35 we believe that the (ND) OIS market is also assigning the possibility that
overnight rates may fall below the repo rate, and hence is pricing in a combination of repo rate
cuts and easy liquidity conditions. As mentioned above, we believe it highly likely that the RBI
will become more proactive in bringing liquidity to neutral levels as it becomes more overt in
supporting growth. If such a scenario develops, we believe it will become common for MIBOR
fixings to fall below the repo rate (Figure 58). From a timing perspective, we believe this is most
likely to occur in CY Q3, as this is the time of year when currency flows back into the banking
system (and combined with a somewhat quieter credit season).

Owing to aggressive pricing, receiving the front end of the (ND) OIS curve is a significantly
negative carry/roll trade and, therefore, we believe one should express the receive bias better in
the belly of the (ND) OIS curve. Once rate cuts arrive and/or liquidity conditions ease, we would
expect front end to outperform on the curve and curve to bull steepen.

We also note that, in the near term, while the RBI is on hold and there is a liquidity deficit, one
can tactically put on flatteners or front-end paid positions to earn carry/roll.

China: continued bear steepening
             Maintain 2s5s and 3s5s curve steepeners, which should benefit from both an
              improving economic outlook and potential liquidity easing to support social financing.

             Maintain paying bias on the back end and look to pay on dips until we see financing
              growth reversing its upward trend.

Our view on China still sees higher rates and a steeper curve on the back of a more positive
macro outlook (although this has been an out-of-consensus call).

Of the two main drivers of the China rates curve, the macroeconomic outlook and liquidity (see
China: Dissociation of policy rate expectations and liquidity premium, 18 February 2011), their
influence has been quite different. The macroeconomy has always been the fundamental driver
of the rates curve and determines the medium-term trend of rates and curve shape (in quarters).
However, liquidity has also been very important as it can dominate the macro outlook for
months, which poses significant mark-to-market risk for investors positioning in China IRS
(mainly IRS indexed to the 7-day repo fixing). As the market is not as liquid as other developed
rates market in Asia ex-Japan, positioning on the basis of macro fundamentals can easily be
knocked out by a short-term liquidity shock. This is why many investors often refer to the China
rates curve as a “liquidity curve”.

However, since 2012 (especially in H2), we have argued, firstly, that the importance of the
liquidity premium is gradually shrinking because of the PBoC‟s fine-tuning of policy. From this
starting point, we published a report (China: Dissecting interbank liquidity, March 2012) that
described in detail the PBoC‟s OMOs, liquidity supply/demand and the various monetary policy
mechanisms available in China. As the PBoC can flexible use either or all of the reverse repo,
repo, PBoC bills and the required reserve ratio (RRR) as policy tools, we expect volatility in the
7d repo fixings to be significantly reduced. As the fixing is settled every three months, we tend
to focus more on a 3m average of the 7d repo fixing as the key proxy for realised front-end
fixing in IRS. The 3m average has been very stable in H2 12 as the PBoC extensively utilizes
reverse repos to fine-tune liquidity. Hence we expect the importance of the macroeconomy to
naturally rise because the impact of the liquidity factor becomes transitory and short-lived. This
thus leads us to focus more on the macro side and we started our out-of-consensus paying bias
recommendations in mid-2012.

Although the global risk backdrop was not in favour of paying trades (and we did have a general
receiving bias in our rates portfolio in 2012), China stands out as the one market in which we
have consistently paid since mid-2012, when the market was deeply bearish on China‟s outlook.
Our confidence came mainly from: 1) the knowledge that 2012 is a key leadership transition
year with a high priority put on the maintenance of “stability” in both political and economic
circles; 2) key leading indicators (M2 and total social financing (TSF)) began to show improved

     The nondeliverable overnight index swap curve.
     India Rates: Analysing OIS pricing and liquidity conditions, 3 October 2012.

Nomura | Asia Special Report                                                                                              28 November 2012

growth, which was good news for an economy driven so heavily by credit in recent years.
Furthermore, the back end of the China rates curve has exhibited a very strong directional
relationship with financing growth; and 3) the gradual approval of large investment projects and
the potential to front-load projects under the 12th Five-Year Plan further bolstered our

Although China rates have sold off by more than 100bp across the curve since July, the market
has just recently started to turn a bit positive on China‟s economic outlook. This is expected as
activity data is showing signs of stabilisation. The bear steepening trend in H2 2012 is driven by:
1) the normalisation of monetary conditions from temporary looseness back to neutral; and 2)
the gradual stabilisation of the economic outlook. For example, the IRS indexed to the 1yr
deposit rate priced in a rate cut from 3.00% to 2.00% in July (there is a technical reason why the
market has some special dynamics but we would not emphasize that here as we do not believe
it critical to our analysis). On these expectations of deep rate cuts, the liquidity premium based
on our framework was deeply negative at around -25bp (the low since 2009 and not far from the
2008 low). This represented a very loose monetary stance priced into the curves, which was
inconsistent with the prudent monetary policy stance. As such we expected these conditions to
be only temporary, though we will admit to the fact that the improvement in real economic
activity arrived a bit later than we expected.

At the moment, the China curves are pricing in a 1yr deposit rate at 2.70% by the end of 2013
and 25bp of liquidity premium, suggesting that pricing has returned to neutral. Again, as we
believe the PBoC will maintain a neutral level of interbank liquidity via its fine-tuning operations,
the more fundamental macro factors are again likely to become the most important driver going
forward. Above-potential growth and higher inflation suggest that there might even be room for
rate hikes in H2 2013 (Our China economist, Zhiwei Zhang, expects two rate hikes in H2 2013;
see China outlook). As such, we continue to hold our bear steepening view on China repo IRS.
In the near term, the calendar new year as well as the Lunar new year (which falls in January
this year) may see a liquidity squeeze, though we are less concerned about the calendar new
year as trillions of RMB of liquidity is expected to be released through government spending in
November and December. We therefore expect any liquidity squeeze into year-end to be very
temporary, with the PBoC well armed with its OMO tools. We believe it more likely that tactical
opportunities will present themselves around the Lunar new year.

Fig. 59: The recent sell-off was led by reduced rate cut                   Fig. 60: … as well as rising liquidity risk premium

4.5%                                                                        1.5%
                                                 1y deposit                                             liquidity premium - 1y
4.0%                                             current                    1.0%
                                                 mid Jul-2012
3.5%                                                                        0.5%

3.0%                                                                        0.0%

2.5%                                                                       -0.5%

2.0%                                                                       -1.0%
   Dec-05 Apr-07 Sep-08 Jan-10 Jun-11 Oct-12 Mar-14                             2008        2009          2010       2011        2012

Source: Bloomberg, Nomura.                                                 Source: Bloomberg, Nomura.

Rates views across the region

China: rates continue to bear steepen
In Asian, one of Nomura‟s long-held out-of-consensus views is that of China experiencing a
policy-led cyclical economic recovery despite its deep structural problems. The strong fiscal and
monetary supports from the government have shown signs of stabilising growth. Although China
rates have sold off by more than 100bp or so across the curve since July, there is still room for
them to move higher, driven by the back end of the curve as the market starts to build in rate
hike expectations in 2013.

Nomura | Asia Special Report                                                                                      28 November 2012

Other than the macro outlook, we continue to note the reduced importance of liquidity dynamics
as a rates market driver into 2013. We have confidently argued since mid-2012 that macro
fundamentals will become the main driver of China rates as the PBoC continues to fine-tune
operations. This is evidenced by language changes in quarterly monetary policy reports as well
as increasingly flexible OMOs. In Q1 and Q2 reports, the PBoC started to put more emphasis
on fine-tuning operations and mentioned specifically reverse repo and repo rates, PBoC Bills
and the RRR as policy tools. In its Q3 report released in November it added phrases such as
“… enhance preemptive-tuning and fine-tuning…” and “focus on maintaining interbank liquidity
conditions stable…” We expect the PBoC to neutralise the impact of liquidity from the balance of
payments via reserve accumulation and other supply/demand factors such as loan expansion
and government deposits with the PBoC and ensuring sufficient liquidity to support credit and
social financing growth at a reasonable pace.

Fig. 61: the macro outlook drives broad rates trends                 Fig. 62: A more stable 7d repo fixing

30%                                                         5.0      9%                               7d repo fixing

25%                                                                  8%                               bill/repo 3m (withdrawal)
                                                            4.0      7%
20%                                                                                                   reverse repo 7d (injection)
15%                                                         3.0
10%                                                                  4%
                                              CPI+IP        2.0
  5%                                          2y                     3%
  0%                                                       1.0       2%
    2007       2008      2009   2010   2011   2012     2013            2011 2011 2011 2011 2012 2012 2012 2012 2013

Source: Bloomberg, Nomura.                                           Source: Bloomberg, Nomura.

Taiwan: rates are likely to bear steepen, which should also widen swap
As China‟s outlook improves, Taiwan stands to benefit as economic linkage with China
continues to strengthen. Given the policy rate is kept at a very low base and liquidity in the
system will remain abundant, the rates curve is likely to steepen to price in rate hike
expectations in mid-2013, in our view (our economist Young Sun Kwon, expects two rate
12.5bp hikes in H2 2013, see Taiwan outlook). Swap spreads will also tend to widen as bond
yields are kept stable by domestic demand and abundant liquidity.

Taiwan‟s rates curve has been largely driven by the back end as the front end and commercial
paper (CP) fixing has stayed at rather accommodative levels compared to pre-2008 crisis levels,
as a function of a relatively low policy rate and abundant interbank liquidity. This is the main
reason why policy rate tightening has usually been partially passed through to CP fixing.
Although the Central Bank of China (CBC) continues to sterilise liquidity in the system, we do
not expect overall conditions to change dramatically as Taiwan remains a small, export-driven
open economy.

The curve, then, has been determined by the back end reflecting the macro outlook, especially
related to the global market. This enhances the link between the back end of the curve and US
rates when the swap fixing spread (between the Taiwan CP fixing and USD Libor) is stable, and
sometimes provides relative value opportunities. We will continue to explore outright and RV
rates opportunities based on the influence of China and the global market (such as the US) on
Taiwan‟s outlook.

Nomura | Asia Special Report                                                                                      28 November 2012

Fig. 63: rate hike expectation is likely to steepen the curve         Fig. 64: The curve shape remains driven by China and the US

6%                                                                    6%                                    10y IRS (USD)      100
                                                discount rate
5%                                              90D CP fixing                                               5y NDIRS (CNY)
                                                                      5%                                                      80
                                                                                                            2s5s, bp (rhs)
4%                                              5y NDIRS                                                                      70
                                                                      4%                                                      60
3%                                                                                                                            50
                                                                      3%                                                      40
2%                                                                                                                            30
1%                                                                    2%                                                      20
0%                                                                    1%                                                       0
  2000        2002      2004   2006    2008    2010     2012            2008      2009      2010       2011     2012       2013
Source: Bloomberg, Nomura.                                            Source: Bloomberg, Nomura.

Hong Kong: expect outperformance relative to USD rates
Hong Kong will also benefit from a stronger-than-expected China rebound. However, the impact
on the HKD rates curve is slightly different from Taiwan‟s due to the currency peg to USD and
low interbank rates. A better economic outlook is likely to attract inflows into HKD and possibly
push the Hong Kong Monetary Authority (HKMA) to defend the peg again in 2013, which points
to abundant liquidity and outperformance of HKD back-end rates over USD rates (i.e. even a
wider USD-HKD spread). We would like to position for this when the back end spread is close to
zero. Our US rates team forecasts higher rates in 2013 and HKD rates have lagged in sell-offs
as a function of the better growth outlook and abundant systemic liquidity.

The spread between Libor and Hibor is not expected to widen further, which is also not against
the view of outperformance of HKD rates, because Libor-fed funds basis has already reached
quite a low level, which limits room for Libor-Hibor spreads to move even more negative.

Fig. 65: HKMA intervention adds downward pressure on rates            Fig. 66: USD-HKD rate spread has less room to tighten

                                       HKD                              225                                          3m fixing, bp
 7.90                                                           9%
                                       HKD 12M fwd
                                       HKD 2y IRS (rhs)         8%      175                                          2y, bp
                                       HKD 10y IRS (rhs)        7%                                                   5y, bp
 7.80                                                           6%      125
                                                                                                                     10y, bp
                                                                5%       75
 7.70                                                           3%       25
 7.65                                                                   -25
 7.60                                                           0%      -75
    2000       2002     2004   2006   2008    2010    2012                2000    2002    2004      2006   2008   2010   2012
Source: Bloomberg, Nomura.                                            Source: Bloomberg, Nomura.

Korea: stable rates, though biased to edge higher
Korea rates have become very stable since the last rate cut in October. Our economist expects
GDP growth and CPI inflation to rise only modestly in 2013, allowing the Bank of Korea (BOK)
to leave rates unchanged (see Korea outlook). Currently, the curve has priced in an even lower
CD fixing and we see a marginal probability of another rate cut. We interpret such pricing as
reflective of asymmetric global risk and the potential impact on the Korean economy. The
Korean rates curve is more likely to move along with global risk sentiment, in our opinion, as we
expect domestic drivers to be less significant in 2013.

Once the US rates curve starts to rise, supported by a better economic outlook in H2, we would
expect the Korean curve to also face pressure to bear steepen. As capital inflows, along with

Nomura | Asia Special Report                                                                                                                                                                                            28 November 2012

strong domestic demand, support KTBs, we expect they will outperform swaps and US
Treasuries under our baseline view for 2013, which points to a wider swap spread and narrower
KTB-UST spread.

Fig. 67: Korean curve still prices in a slight rate cut                                                                                                                    Fig. 68: capital inflows are likely to help KTBs outperform

 8%                                                                                                                                                                         400
                                                                                                                                   3m CD fixing                             300
                                                                                                                                   Base rate
 5%                                                                                                                                                                         200
 2%                                                                                                                                                                            0
                                                                                                                                                                               2000      2002     2004   2006    2008      2010   2012
 1%                                                                                                                                                                         -100
 0%                                                                                                                                                                                                      KTB-UST 10y spread, bp
   2000 2002 2004 2006 2008 2010 2012 2014                                                                                                                                  -200                         KRW-USD policy rate spread, bp

Source: Bloomberg, Nomura.                                                                                                                                                 Source: Bloomberg, Nomura.

India: maintaining a bullish bias
We continue to maintain our bullish bias on Indian rates given our expectation of continued
monetary easing into 2013. Our economists‟ expectations of inflation to peak in Q4 2012 and for
a very shallow recovery in 2013 (see India outlook), allowing the RBI to ease further, remain
supportive of our bullish rates view. This, along with our view that the RBI will proactively
manage liquidity conditions should aid this bullish bias further.

We believe the RBI‟s easing of monetary conditions and liquidity dynamics to remain the key
drivers of rates in India in 2013. From a cash bonds perspective, we believe low credit demand
in the economy, consistent with our weak growth outlook, will keep demand for cash bonds in
the banking system strong. This, combined with demand from the RBI in the form of its OMOs,
aimed at injecting liquidity into the system, should outweigh supply pressures emanating from
the government's high fiscal deficit. We would not be surprised if the RBI becomes more
proactive and brings liquidity in the banking system back to neutral levels, which will be
consistent with its stance of keeping liquidity within +/-1% of NDTL. In terms of yield trajectory,
we expect the 10yr to reach 7.8% in Q1 2013 before consolidating in Q2 2013 (which is typically
a high issuance quarter) and starting a gradual trajectory lower to end 2014 at 7.5%.

In (ND) OIS as well, the weak domestic growth outlook and RBI OMOs should keep the
market‟s receive bias in the belly (3-5yr) of the (ND) OIS curve. We also note that, in the near
term, while the RBI is on hold and there is a liquidity deficit, one could tactically put on flatteners
or front-end paid positions to earn carry/roll. However, once rate cuts arrive and/or, more
importantly, liquidity conditions ease, we would look to switch into steepeners as we would then
expect front-end (ND) OIS to outperform on the curve. In our view, the most likely timing of easy
liquidity conditions is Q2 and Q3 of the calendar year. The expected recovery in activity data
should also aid the steepening of the (ND) OIS curve in H2 2013 (see India outlook).

Fig. 69: Indian bond yield curve                                                                                                                                           Fig. 70: MIBOR-repo rate spread, 1m average

  20                      3 Month Change                                                                                                                                    150                 1M Avg (MIBOR - Repo Rate (in bps))

                          1 Month Change                                                                                                                 8.4%
  10                      Latest Yield Curve (RHS)                                                                                                                          100

                                                                                                                                                         8.2%                50


 -10                                                                                                                                                     8.0%
 -20                                                                                                                                                     7.8%
                                             8.79 2021
                                                         8.15 2022
                                                                     9.15 2024

                                                                                             8.26 2027
                                                                                                         8.97 2030

                                                                                                                                 8.33 2036
                                                                                                                                             8.83 2041
                                                                                                                     8.28 2032
         7.17 2015
                     8.07 2017
                                 8.19 2020

                                                                                 8.33 2026

                                                                                                                                                                                    10              11                12

Source: Bloomberg, Nomura                                                                                                                                                  Source: Bloomberg, Nomura

Nomura | Asia Special Report                                                                                        28 November 2012

Singapore: remain received
As stated earlier in this section, we maintain our bias to receive SGD IRS rates in tenors which
offer favourable volatility-adjusted carry or slide. While recent activity data have disappointed,
we do not believe this will significantly affect the MAS‟s assessment of the domestic growth
outlook. Against this backdrop and with headline inflation remaining well above its long-term
historical average, we believe a change in policy stance is unlikely. As a result, we believe the
policy backdrop will remain conducive to receive, as hawkish monetary policy translates into low
front-end rates via the swap offer rate (SOR) construction (Figure 71).

While the below-trend growth outlook and regulatory-driven demand in Singapore should put
downward pressure on the IRS and SGS curves, the risks to these views come from the robust
historical relationship with the USD curve. Should the “Phase 1” scenario mentioned above of a
positive environment for riskier assets be realised, then the risk to outright received positions in
the back end of the curve would be from the steepening of the USD curve and be transmitted to
the SGD curve via the strong historical beta. We maintain our recommendation to receive the
back end of the SGD curve against a regression-weighted (0.5) amount of USD, as this results
in modest positive carry and captures the underlying relationship between the two curves. That
said, we eschew adding to these positions at this stage as valuations suggest the SGD 10yr is
fairly valued to its USD counterpart (Figure 72) and instead wait for the SGD curve to cheapen
before adding.

Fig. 71: SGD SOR 6M and selected IRS - %                               Fig. 72: SGD IRS 10yr vs USD IRS 10yr is fairly valued, bp

 5%                                     Swap offer rate 6M                80
                                                                                        Residuals - y:SGD 10yr; x:USD 10yr, bp
                                        SGD IRS 3yr                       60
 4%                                     SGD IRS 5yr
                                        SGD IRS 7yr                       40
 0%                                                                      -40
-1%                                                                      -60
      08            09         10       11          12                         08        09            10     11         12
Source: Bloomberg, Nomura                                              Source: Bloomberg, Nomura

Malaysia: continued foreign interest in the government bond market
In Malaysia, foreign investor interest in the domestic market has been robust for the last three
years, bringing foreign ownership of Malaysian government bonds (MGS) to 42.1% in
September from 34.6% a year earlier (Figure 73). Unless there is a general bout of risk
aversion, we expect this to continue into 2013 amid continued investor and FX reserve-manager
allocations to emerging market debt, as a means of diversification given the ongoing difficulties
in many European sovereign debt markets. Even with Nomura economist Euben Paracuelles‟
forecast of 50bp of policy rate hikes by Bank Negara Malaysia (BNM) in H2 2013 (see Malaysia
outlook), we believe that this dynamic will remain largely intact unless we see a substantial
surprise to the upside in terms of tighter monetary policy. In terms of what part of the curve is
attractive, using our government bond relative value analytics, the forward curve suggests that
the biggest cushion to add duration lies beyond the 10yr part of the MGS curve. From here, our
government bond spline suggests that each of the 2025, 2026 and 2032 bonds are cheap to the
curve (Figure 74).

We do not expect any dramatic policy-induced moves in the MYR IRS curves in H1 given the
challenging external backdrop. As we approach the timing of our forecast rate hike in Q3, with
the associated pickup in the economic backdrop, we would expect to see steepening pressure
on the curve. However, given the negative carry of holding a 2s5s steepener (-8bp over 6M)
and the near-term hurdles from advanced economies, we believe the best course of action is to
wait for these hurdles to be cleared (or realised) before putting on a steepener postion that we
would intend to hold for a long time. Still, that does not preclude us from tactically looking at
steepening trades should the 2s5s spread once again approach historical lows.

Nomura | Asia Special Report                                                                                                28 November 2012

Fig. 73: Increased foreign interest in MGS                                Fig. 74: Rich(-)/Cheap(+) MGS market, bp

  45                                                                            15
             Foreign ownership of MGS - %
  25                                                                             0

  15                                                                             -5
                                                                                -10        Rich(-) / Cheap (+)
    5                                                                                      Median of MGS spread (past 3M)









        05     06       07          08   09   10   11    12

Source: CEIC, Nomura.                                                     Source: Bloomberg, Nomura.

Thailand: bias to be long bonds
We maintain our constructive view of the bond market in the medium term as there remains a
substantial cushion to extend duration from the 7yr part of the curve (Figure 75). Our forecast of
stable inflation and no rate changes from the Bank of Thailand in 2013 offer support. This view
also benefits from Craig Chan‟s bullish THB view over the medium term (see FX outlook), so
bonds can also be used as an overlay to FX positions. We believe that both the asset allocation
shift to higher quality Asian sovereigns (Figure 76), as well as local demand driven by the
demographic outlook, will continue to contribute to the attractiveness of the Thai bond market,
with light foreign involvement at 15.9% minimising its external vulnerability.

However, there is a market concern regarding additional bond issuance due to fiscal expansion
and this has manifest itself in a 5s10s steepening of the IRS curve. That said, we believe that if
additional funds are needed then alternative sources that will not weigh on the yield curve – we
would expect retail savings bonds or promissory notes directly to the private sector (which has
substantial excess liquidity) to be used. Moreover, the public debt-management office has been
within 0-5% of its benchmark issuance target over the past four years, so it does possess a
level of credibility.

We expect a largely range-bound environment in THB IRS going into 2013, as there are no rate
changes reflected in the curve, which is in line with our forecast for no changes in policy settings
through the whole of next year. As we alluded to earlier, there has been a significant steepening
of the 5s10s slope from 25bp to 45bp over the past three months and given our view that there
will be little deviation from the announced benchmark issuance plan, we expect the slope to
normalise. However, as the slope has yet to show any signs of flattening and may continue its
steepening momentum in the near term, we avoid entering a THB 5s10s flattener until we see
clearer signs that the near-term steepening has abated.

Fig. 75: Cushion to add duration from 7yr and out                         Fig. 76: THB bond foreign ownership less crowded- %

5.5%                                                                            50%

                        Par Cpn Curve                                                                 Indonesia
5.0%                    Forward Curve                                           40%                   Korea
                        Spot Curve                                                                    Thailand

2.5%                                                                             0%
        0           5          10        15   20    25        30                      07        08      09        10    11         12

Source: Bloomberg, Nomura.                                                Source: CEIC, Nomura.

Nomura | Asia Special Report                                                                                   28 November 2012

Indonesia: high beta helps early in 2013, but H2 rate hikes to squeeze out
risk premium
The performance of IDR government bond positions will be largely dependent on the global
risk environment given the high-beta nature of the asset class, in our view (Figure 77). While
Korea, Thailand and Malaysia have experienced an increase in foreign interest in their local
government bond markets, foreign ownership of IDR government bonds has remained stable
over the past year, near its October 2012 reading of 30.0% (Figure 78). This relative stability
in the bond market is reassuring for existing bondholders, as the benign risk environment
allows for the realisation of the high coupons on the curve while minimising mark-to-market
risk. Should we see a positive resolution to the issues which continue to weigh on developed
markets, then there is further scope for capital gains as we remain below the peaks in foreign
ownership seen in 2011. One potentially limiting factor for new investors (as existing holders
likely have accumulated gains to act as a cushion) is the lack of term premium in the bond
curve. At current levels, there is no term premium in the curve out to the FR40s (Sep 2025)
and if we add our economist Euben Paracuelles‟ end-2013 forecast for the BI rate of 6.25%
(see Indonesia outlook), then the first signs of term premium do not show up until the FR45s
(May 2037).

Fig. 77: Rolling correlation of returns remains high                Fig. 78: Foreign ownership of bonds stable in Indonesia

-0.8                                                                35
                    Rolling 6M correlation between IDR 20yr                    Non resident holdings of IDR
                    bond vs S&P 500, inverted scale                            government bonds as % of
-0.6                                                                30
                                                                               total market cap

-0.2                                                                15
 0.2                                                                  0
       06      07        08     09     10      11      12                 05   06     07     08     09    10    11     12

Source: Bloomberg, Nomura.                                          Source: CEIC, Nomura.

Nomura | Asia Special Report                                                                                       28 November 2012

 This portion of the Report has been prepared by a Desk Analyst and is NOT a research report under U.S.
 law. The desk commentary portion of this report is NOT a product of the Fixed Income Research
 Department and is NOT covered by the research analyst certification provided in Appendix A-1.
 To our U.K. clients: this portion of the Report has been produced by and for the primary benefit of a
 trading desk.
 As such, we do not hold out this Desk Commentary as being impartial in relation to the activities of this
 trading desk.
 For additional information concerning the role of trading desk analysts, please see the important
 conflicts disclosures beginning at page 59 of this report.

Credit outlook in the EM context

A bumpy road to tighter spreads is how we would characterise our expected path of emerging             Asia Corporates Desk Analysts
market (EM) credit performance in 2013. Achieving a similar return as in 2012 (EMBIG YTD
returns at 16% and CEMBI at 15%) will be very difficult with yields, particularly in EM high grade     Pradeep Mohinani
                                                                                                       +852 2536 7030
(HG), already so low. Much of the outperformance will have to come from EM high yield (HY),  
where yields still offer a pick up over US HY. Relative to an average of 70-80bp of tightening in
                                                                                                       Annisa Lee
EM corporate HG in 2012 and 180-230bp in HY, we expect another 30-50bp of tightening in HG             +852 2536 7054
cash and 90-120bp in HY corporate cash by year-end 2013. This is based on the expectation of 
HG ending the year on average about 180bp from the current 230bp (using JACI as a reference
                                                                                                       William Mak, CFA
guide) and HY at 470bp from 570bp.                                                                     +852 2536 7059
The key factors driving our bullish view on EM credit spreads are:
                                                                                                       Agnes Wong
         Very supportive technicals given a low-yield environment and wider spreads relative to       +852 2536 7434
          US credit, which is likely to offset heavy issuance.                               

         Better fundamentals and growth prospects in EM relative to developed markets (DM)            Gourav Dhavale
                                                                                                       +852 2536 1309
          make investing in EM credit an attractive value proposition and relative safe haven.

Kicking off 2013, we believe LatAm credit offers the best value proposition due to stronger            Abhimanyu Talwar
technicals with wider spreads levels alongside – relative to Asia – a comparable size of               +852 2536 7065
redemptions in terms of principal and coupons. Asia remains subject to heavy issuance and    

comparatively tighter spreads. Central and Eastern Europe, the Middle East and Africa
(CEEMEA) has the widest spreads of the three regions, but is subject to geopolitical risks in the
Middle East and volatility transmitted from the eurozone to Eastern Europe, and similarly,
governance risks in Russia and Ukraine.

Fig. 79: Principal and coupon redemption and average spreads
 (In US$ bn)                      AEJ                    LatAm                  CEEMEA
 2012                             48.7                    42.1                    62.7
 2013                             48.8                    43.1                    63.1
 Avg Spd
 Current*                          289                     404                      334
 YE2011                            402                     475                      472
 Chg                              -113                     -71                     -138

Note: *CS EM Corporate bond spreads. Source: Bloomberg, Dealogic and Nomura.

Key macro drivers for EM credit in 2013
Dim growth outlook for DM and brighter for EM – Nomura Economics‟ house view is for US
GDP growth to weaken in 2013 (from 2.1% in 2012), while the European recession is expected
to deepen, with GDP contracting by 0.76% in 2013 (from -0.4% for 2012). EM growth, on the
other hand, being increasingly driven by domestic demand, is expected to pick up slightly to
5.6% in 2013 (from 5.4% in 2012) due to upticks in LatAm and EEMEA. The key concern with
the US and Europe remains fiscal tightening causing a drag on growth. However, the
transmission in market volatility (using VIX and VStoxx) is likely to remain constrained, with the
belief that central banks remain ever-ready to inject liquidity into markets, offset by tighter bank
lending, particularly in the EU.

Nomura | Asia Special Report                                                                           28 November 2012

EM remains flush with liquidity, with more to come – most EM countries with a reasonable
fiscal balance sheet have maintained supportive fiscal spending programs and monetary
policies that are either loose or neutral, which has for the most part attracted capital inflows. We
believe such trends are unlikely to change meaningfully in 2013, though there is an upward bias
to raising policy rates to counter any pick-up in inflationary trends. Exceptions where rates are
expected to be lowered include India, Hungary and South Africa. This backdrop should be
conducive to generating additional inflows into EM credit.

China remains the wild card growth in both DM and EM – while China‟s growth has
accelerated recently, benefiting from higher infrastructure spending, its sustainability remains in
question. Our economists forecast quarterly GDP growth of 8.4% in 4Q 2012 slowing to 7.0% by
4Q 2013. The equations around fixed assets investment-to-GDP and total social financing
relative to bank financing are stretched on an absolute basis, compared to the size of the
economy – and nonperforming loan (NPL) levels are creeping higher. The growth implications
for the rest of the world are deep, and weaker US and European demand for commodities and
consumer goods should, in turn, also affect China‟s growth engines. The second-order impact
will be reflected in capital flows, including portfolio and FDI inflows, as well as external M&A and
purchases of UST.

Mixed commodity price outlook with base metals higher, energy and food lower –
commodities, a central driver in EM as most economies are either major exporters or importers,
are certain to realise the effects of China‟s growth trajectory, particularly if the slowdown turns
out to be deeper than expected. In any event, forecasts currently appear to be much more
optimistic relative to futures. Nonetheless, precious and base metals (gold, aluminum, zinc)
point to an upward trajectory, with copper being the exception declining from mid-2013
onwards. In terms of energy, oil and gas are projected to fall over the next 12 months, with a
similar direction for food (corn, wheat, soybeans). Coal is the exception in the energy space
having fallen sharply in 2012 and looks set for a rebound. The implications are that non-core
inflationary inputs should be contained.

Technicals should remain supportive – with a US policy rate and 10-year UST projected
through 2013 at 2.5% by our US rates strategists, additional liquidity supplied by the Fed
through QE3 and possibly by the ECB via its OMT program, the pressure to increase risk is
likely to remain, resulting in additional flows into EM credit. Further supporting this thesis,
general credit rating trends are likely to remain benign though with a slight negative bias and
global HY default rates are also expected to remain roughly unchanged at around 3.0%
according to Moody‟s in 2013. At the investor level, real money and private banks are likely to
end 2012 with a reasonable cash position, with real money at around 4% cash levels and still
seeing inflows. We would also note that the fund flows into EM compared to US HY have been
steadier, suggesting spread performance should also be steadier, with pick up in favor of EM
over US HY.

Issuance to remain high, but we are not concerned just yet given the technical backdrop
– following record issuance YTD of US$310bn – split between Asia with US$105bn, CEEMEA
with US$111bn and LatAm with US$93bn – we expect a similar, if not higher level of issuance
in 2013. There are a number of key drivers to consider, which were reflected in 2012 issuance
and that are, in our view, likely to repeat in 2013. Sovereign issuance accounted for only
US$61bn of this YTD total, while EM benchmarked inflows should continue to be skewed in
favor of the EMBIG, implying that sovereigns are likely to be better supported through volatile
markets. With the phasing-out of old-style LT2/T1 capital, senior bonds should continue to
dominate bank issuance, but also at reduced levels following sizeable issuance in 2012 and
relatively low maturities in 2013. We could start to see Asian banks (including Australian and
Japanese banks) opportunistically issue new-style capital. Similarly, with loan-to-deposit ratios
having risen over past years across EM – resulting in EM banks generally tightening lending
standards and European banks reducing their exposure as part of their deleveraging – we
expect corporate issuance to be higher in 2013. Other features of issuance that are likely in
2013 include issuance due to M&A activity, with the E&P sector involving the likes of CNOOC
with its Nexen acquisition, Petronas with Progress Energy and TNK-BP with Rosneft. We note
that principal and coupon redemptions in 2013 are estimated at US$155bn, similar to the
amount redeemed in 2012.

Nomura | Asia Special Report                                                                       28 November 2012

Asia themes

Downgrade pressure on selective sovereign ratings is rising, the Philippines being the
exception: With the slower growth in EM Asia in 2013, we expect the sovereign upgrade trend
to slow and a greater focus on downgrade risks instead. The Philippines is the most likely
candidate for further upgrades to come through in 2H, which will be a function of the
improvement in a broadening/deepening of fiscal revenues to GDP, continued infrastructure
investment and the reduction of public debt to GDP. India, Sri Lanka and Vietnam are potential
downgrade candidates, with India being a 50/50 probability, in our view.

Key regional macro stories to track: The main issues that will prevent an Indian downgrade
are the political will to carry through with announced reforms; political stability maintained
through the parliamentary process; the external balance sheet not deteriorating; inflation being
contained and the fiscal balance sheet not deteriorating sharply. In Vietnam, the focus is on
bank NPLs and potential drag on the sovereign‟s balance sheet while the government attempts
to resuscitated growth without inflation rising. For Sri Lanka, the external balance will be key
given low FX reserves and the high trade deficit. In terms of political change, besides
challenges to the central government, India has a heavy state election year. Other countries
where the winds of political change may blow include Indonesia in the run up to the presidential
election due to be held in 2014 and Malaysia, where national elections are now expected to be
held by March 2013.

Corporate earnings for 2013 are likely to moderate versus the trough a year back, driven by
higher sales volume, product prices and margin improvements reflecting the economic recovery.
The exception will be commodity companies likely reporting flat or lower earnings.

Capex requirements in 2013 will largely depend on the M&A risk appetite of IG corporates
while HY issuers will likely have limited capex to complete expansion plans.

Leverage may slightly improve due to better earnings, the working capital situation may not
improve, particularly among HY corporates, especially for Chinese issuers with SOE customers.
That said, we acknowledge that most issuers have considerable bills receivables which reduces
non-payment risk of their end customers.

Despite a benign corporate outlook, credit ratings will likely be skewed to a downgrade
bias with IG corporates such as China Metallurgical, Yanzhou Coal, Sinochem, KT Corp, SK
Telecom and Noble Group potentially being downgraded by the ratings agencies. In the HY
space, we may see some upgrades (mainly Outlook changes) among China property names
like Shimao, Yanlord and Country Garden, while selective commodities, industrials and property
names such as Bumi Resources, China Oriental, West China Cement, Fufeng, Mongolian
Mining Corp, SPG Land, Renhe and Powerlong may experience negative rating actions.

Beyond issuers with bonds maturing in 2013 with refinancing needs, we will be watching for
credits trading above their call price adding another wave of refinancing.

Asset quality deterioration in India and Vietnam: Indian banks‟ average NPL ratio has
deteriorated to 3.6% in September (from just under 3% in March) and could rise further to over
4% by March 2013, as India‟s economic growth has yet to bottom out and the NPL cycle
generally lags by a few quarters. Vietnam is the banking system in Asia that will face the most
severe asset quality challenges, as understated NPLs start to surface with loan growth having
slowed to 3% YTD (from >30% previously). We expect Vietnam‟s systemic NPL ratio to rise to
over 10% in 2013 (from 8.8% in Sep 12).

FC liquidity improvement in Korea, Australia and Singapore: Korean banks‟ FC
loan/deposit ratio (LDR) improved to 315% in June (from 419% in December 2010), and they
have increased their FC liquidity buffers and committed credit lines. They have also diversified
their FC funding into other local markets, with the proportion of FC debt denominated in ex-G3
currencies rising to 15.6% in June (from 11.2% in December 2009). As Australian bank deposit
growth has outpaced loan growth over the past few years, FC funding had fallen to 17.5% of

Nomura | Asia Special Report                                                                   28 November 2012

total liabilities in June (from 25.0% in December 2006). Singaporean banks have also sharply
slowed their USD loan growth recently, resulting in a lower USD LDR of 120-130% in
September (from 150-160% in December 2011).

Senior supply expected to be lower than in 2012: With significantly lower refinancing needs
in 2013 and improving FC liquidity, we expect supply from Korea ($3-4bn) and Singapore ($1-
2bn) to be fairly manageable. We believe Indian and Thai banks are likely to issue more USD
bonds ($9-10bn and $2-3bn, respectively) to fund overseas loan growth. We factor in another
$5-6bn from southeast Asian, Chinese, Hong Kong and Mongolian banks, taking our total
expected senior issuance from Asian (ex Japan) banks to around $20-25bn in 2013.

Asia trade ideas
Short PTTEPT 21s at T+205bp, target T+225bp

Short PTTEPT 42s at T+200bp, target T+240bp

Short PCCW 2022s at T+292bp, target T+325bp

Short SINOCH 2040s at T+230bp, target T+285bp

Short LIHHK 2017s at T+265bp, target T+290bp

Short LIHHK 2022s at T+276bp, target T+320bp

Short RILIN 2040s at T+260bp, target T+325bp

Short RILIN 2020s at T+240bp, target T+280bp

Short RILIN 2022s at T+260bp, target at T+300bp

Long YLLG 2017s at 104 ask at 8.2%, target 7.6% and Long SHIMAO 2018s at 110.6 ask
8.1%, target 7.6%

Long GEMDAL 17s at 100 ask 7.1%, target 6.5%

Long AGILE new 17s at 108.75 ask 7.5%, and AGILE old 17s at 105 ask 7.2%, target 7% and

Long CHINSC 16s at 96.5 ask 12% and CHINSC 17s at 99.9 ask 11.6%, target 11.2% and

Short SUNAC 17s at 105 ask 11.1%, target 14%

Long CSMAU 2016s at 84 at15% YTW, target 89 with 13% YTW

Long ATIAU 2018s at 74 at 19.7% YTW, target 84 with 16% YTW

Long VEDLN 2018s at 110 at 7.3%, target 113 at 6.7%

Long VEDLN 2021s at 104.12 at 7.6%, target 107 at 7.2%

Long FMGAU 2019s at 102 at 7.75% ask-YTW, target 104.50 at 7.15% ask-YTW

Long BTELIJ 15s at 46.25 at 53.1% ask-YTW, target 61.25 at 36.8% YTW

Long GJTLIJ 14s at 100.6 ask, target at 100 at 10.25% YTW

Long HYVANL 16s at 94 at 10.8% ask, target at 96 at 10% YTW

In banks, we are Overweight old-style bank capital relative to senior:

         Long a basket of Australian bank T1s including NAB USD 5.486% Pnc15 (5.0% ask;
          target 4.0%) and NAB GBP 5.62% Pnc18 (6.7% ask; target 5.5%)

         Long CHIFIN UT2 5.625% Pnc15 (5.1% ask; target 4.0%)

Like Asian old-style LT2s in general, but would suggest a barbell strategy:

         Long WSTP LT2 3.625% 23nc18 (Z+243bp ask; target Z+220bp)

Nomura | Asia Special Report                                                                      28 November 2012

         Long CINDBK LT2 3.875% 22nc17 (Z+325bp or 99.45 ask; target Z+300bp) vs Short
          BNKEA LT2 6.375% 22nc17 (Z+255bp or 112.98 bid; target Z+275bp)

Be selective in Asian bank seniors by focusing on laggards and guaranteed deals with attractive

         Long DAEHIM senior 42nc17 (Z+267bp or 99.31 ask; target Z+235bp) with credit
          facilities from KDB/Woori/ Hana

         Long CHRESO 2017 (Z+164bp ask; target Z+140bp) with standby LC from DBS

         Long BCHINA (Aviation) senior 2017 (Z+263bp or 97.80 ask; target Z+240bp; BBB-/A-)
          vs Short CIIH senior 2022 (Z+274bp or 98.42 bid; target Z+290bp; BBB-/BBB)

         Long RHBCMK senior 2017 (Z+218bp ask; target Z+200-205bp)

         Long BOBIN senior 2016 (Z+295bp ask; target Z+270bp) vs Buy SBIIN 5yr senior CDS
          (280bp ask; target 305-310bp)

         Long TDBM senior 2015 (8.8% or 99.375 ask; target 7.9%) vs Short CTGVN senior
          2017 (9.1% or 96.125 bid; target 10.0%)

Nomura | Asia Special Report                                                                28 November 2012

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 7-Aug-12           Asia's inflation wildcard
 2-Aug-12           Indonesia: Policy swings
 31-Jul-12          India: A poor monsoon and its impact (Q&A)
 9-Jul-12           South Korea: Prolonged low growth, inflation and rates through 2013
 31-May-12          Pan-Asia: Inventory cycle threatens a slow recovery
 29-May-12          China's peaking FX reserves
 2-May-12           India: Make or break
 23-Apr-12          The China compass
 16-Apr-12          Korea: Uncomfortable trade-off
 11-Apr-12          India: Four cyclical tailwinds to watch
 27-Mar-12          Capital account liberalisation in China
 9-Mar-12           India budget preview: Fiscal cheer
 1-Mar-12           Asia: What if oil prices keep rising?
 23-Feb-12          Philippines – Fiscal space to maneuver
 16-Jan-12          Decoding India‟s stubbornly high inflation
 20-Dec-11          Implications from North Korea
 18-Nov-11          A cold winter in China
 3-Nov-11           Thailand: Dealing with another disaster
 31-Oct-11          China Risks
 19-Oct-11          Korea: Falling, converging bond yields
 21-Sep-11          China: The case for structurally higher inflation
 8-Aug-11           Global market turbulence: Implications for Asia
 7-Jun-11           Indonesia: Building momentum
 10-Mar-11          Vietnam: Prioritizing macro stability
 3-Mar-11           South Korea‟s demographic sweet spot
 14-Jan-11          India's 2011 outlook: Rising symptoms of a supply-constrained economy
 1-Nov-10           The case for capital controls in Asia
 11-Sep-10          The coming surge in food prices
 6-Aug-10           Another step towards becoming an offshore RMB centre
 28-May-10          The heat is on
 26-May-10          Brinkmanship returns to the Korean peninsula
 9-Nov-09           China: Not just an investment boom
 19-Oct-09          What Japan‟s 1980s experience means for China
 8-Sep-09           South Korea: Household debt: Myths and reality
 23-Jul-09          China & Hong Kong: RMB trade settlement: New opportunities, new risks

Nomura | Asia Special Report                                                                                            28 November 2012

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Nomura | Asia Special Report                                                                                                          28 November 2012

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Nomura | Asia Special Report                                                                                                         28 November 2012

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